Is the Death of Active Management greatly exaggerated?
If the trade press is to be believed, the days of active fund managers are numbered and we will soon be replaced by index trackers, smart beta products and, ultimately, robots!
Assets managed by passive funds rose 18 percent in 2016, according to Morningstar, and Moody’s estimates that passively managed investments may make up more than 50 percent of all investments by 2024.
Whilst we have nothing against these products per se, we believe active management should have a significant place in any investor’s portfolio.
There can be little doubt that the rising popularity of passive investing is connected to the sustained strength in global stock markets since the market low in March 2009. Passive investors, however, need to bear in mind that markets can go down as well as up. When they do, passive investments will fall just as much as the index. By contrast, an actively managed fund can protect against downside through holding more defensive, less cyclical stocks than the index and also holding cash.
In addition, certain events over the last 12 months provide us comfort that the death of active management is greatly exaggerated.
For example, the movement in the Apple share price from a low of $90 in May 2016 to its current level of $155 – a rise of 72% in a year or, in monetary terms, a staggering $325bn – raises a key question. How could the share price of the biggest, and most heavily scrutinsed company in the world, be mispriced to such an extent by the market?
This movement is all the more remarkable given there have been very limited changes to Apple’s consensus earnings estimates over this period of time. Clearly global stockmarkets have risen over the last 12 months; Warren Buffett has bought 133m shares in the business (which represents 2.5% of the company or a whopping $20bn cash outlay); and the market is anticipating a very successful launch of the new all-singing and all-dancing iPhone 8 in September this year (which co-incides with the 10-year anniversary of the first iPhone launch).
However, the bottom line is that 12 months ago, the market was simply placing far too low a valuation on Apple’s current and future business prospects and its $260bn gross cash pile.
The implications of such a mispricing are significant. Firstly, it is great news for all active managers whose raison d’etre is the belief that markets are inefficient. If Apple can be incorrectly priced to such an extent, there must be even greater pricing anomalies amongst smaller stocks that have little, if any, coverage. It also highlights the importance of active managers who are able to take a long-term view and take advantage of market volatility to buy shares when they are trading at depressed levels. Similarly, with income investors is it optimal to view dividend security as equivalent to the size of the company, or are other factors worth considering? Clearly, this is something index trackers are unable to do.
It should also be pointed out that this is not just an Apple-specific phenomenon. Some of the share prices of the largest companies in the world have also enjoyed material share price movements in the last year. Shares in companies such as BP, RD Shell, HSBC and Rio Tinto have all increased in value by more than 40%.
Our research today is finding many examples of stocks which we believe are currently mis-priced and as active managers, we can take advantage of these anomolies for the benefit of our investors. One such example is IBM, where we have taken advantage of the recent share price weakness, ironically caused by Warren Buffett reducing his stake in the business, to buy more shares. We think the market is too pessimistic regarding IBM’s ability to sustainably increase its revenue and profits from current levels. When the business finally returns to growth, we expect the shares to re-rate from their current low levels.
Looking forward, as QE unwinds and interest rates start to normalise, we expect more volatility and greater dispersion between individual stocks and markets. These conditions should allow active managers to demonstrate that their place in investors’ portfolios is more than deserved.
Executive Director, Saracen Fund Managers Ltd and Co-Manager of the TB Saracen Global Income and Growth Fund