The decade after the 2008 financial crisis was characterised by low and stable inflation, relatively synchronised economic policy across major nations, and an existential challenge to the concept of active (more hands-on) management.
That challenge was primarily a structural one, driven by technological advances enabling the rise of low-cost passive investment vehicles, such as exchange-traded funds, better known as ETFs. These advances are positive: just as M&G’s launch of the UK’s first unit trust and the thrift plan for small regular savings (in 1931 and 1954 respectively) made diversified baskets of investments available to ordinary households, recent financial innovation has helped lower costs for investors.
However, active investment strategies have also come under fire over this period for failing to meaningfully outperform these passive investments, causing some to question whether active management is even worth pursuing. It is true that investors in aggregate should not be able to outperform the passive index, but professional active managers make up only a subset of the total range of participants trading the market at any one time.
Not only are there private investors, but also a whole range of investor types that won’t be captured in active peer groups: staff who own stock in their own companies (which can be sizable in the tech space), investors with different benchmarks, and institutions like sovereign wealth and pension funds.
We are clearly firm believers in the role to be played by active investments. It’s not just a key part of the very process which makes markets more efficient, but also an activity with the potential to provide investors with superior returns compared with passive investments. Viewing the last decade through a macro lens not only explains why active management has been less valuable for investors over the period, but also suggests reasons why it may have a role to play in 2024 and beyond.
Market and macro conditions
The past 10 years have seen the largest country in global indices (the US) outperform the rest of the world, and the largest stocks within that country (in the technology sector) outperform a more diversified basket:
Company earnings growth has been a key element of this, but so have the low costs of funding that have allowed these companies to embark on new projects and takeover competitors. Such an environment makes it extremely difficult for active global equity managers to add value, unless they are prepared to adopt even more risk.
At the same time, credit markets like bonds (loans usually issued by a government or company) have seen a step-down in average default rates (when a borrower fails to maintain interest payments or repay the amount borrowed when it’s due) since the early 2000s (see Deutsche Bank’s: 2022: The End of the Ultra-Low Default World? from June 2022), arguably caused by very low interest rates and the impacts of direct policy support. This has made active managers less able to demonstrate value by identifying the most vulnerable countries.
In multi-asset and macro investing (investing driven by global macroeconomic events), it’s been an environment in which both fixed income (bonds) and growth assets (equities or shares in a company, property and infrastructure) have been supported by low and anchored interest rates, which has prompted positive returns across almost all asset classes. As a result, the returns generated by one asset class over another have been relatively muted for much of the period, particularly since these conditions have also resulted in diversification between bonds and equities in bouts of stress.
Lastly, the coming together of policy approaches in much of the developed world has meant that there hasn’t been the extent of currency volatility that existed from the 1970s to the 1990s, meaning potentially less volatility and opportunity for investors looking overseas as well.
Looking forward. A new regime?
It remains to be seen how far the pandemic and its aftermath prompt a break with the regime that has coincided with active management’s biggest challenges. Whatever one’s own view, it seems that the best conditions for active managers are when assets move in different directions, and when those differences in return are material. Periods of transition in markets can bring these conditions, as can uncertainty.
So while the world of declining and then low interest rates and inflation were a correlating force for the most part, the last couple of years have created potential opportunities for active managers:
- Differences in views about which companies will be the winners and losers in the world to come have resulted in elevated dispersion in equity and credit valuations, potentially increasing the rewards to those who get these calls right.
- Cash and secure income sources are now and may continue to be a potentially viable option for many more investors going forward, and become a new tool for active managers when valuations look positive in other assets.
- A potentially tougher environment for companies, with higher costs of capital and the growth of labour power making it more important to be able to select winners and avoid defaults in corporate bond and lending markets.
- Passive indices, which may be highly concentrated in a small number of stocks or bonds such as technology, or a particular region like the United States, could offer less diversification.
These are long-lasting themes which are likely to have an impact over a far more relevant time frame than simply the next twelve months. However, as the pandemic and its aftermath have demonstrated, major changes in the environment can also be created by shorter-term shocks.
Stuart Canning is a fund manager at M&G Investments
Charity Finance wishes to thank M&G for its support with this article
