LONDON (Reuters) - With political uncertainty rising, global economic growth far less synchronised than last year and earnings growth becoming less uniform too, it’s a stock picker’s paradise. Or it should be.
Yet despite the more favourable investing backdrop and a noticeable slowdown of inflows into passive investment funds, the signals that active managers are beating their benchmarks are mixed.
On the face of it, active managers, who attempt to identify market inefficiencies to deliver higher returns for investors, should be doing relatively well.
The first half of the year was marked by new highs for Wall Street and world stocks in January, a record surge in volatility in February and markets’ subsequent struggle to regain that momentum as the global growth outlook began to deteriorate.
The S&P 500 ended the first half up less than 2 percent, the MSCI world index down less than 2 pct and European stocks down almost 3 pct. Common to all of them was a growing lack of direction, confidence and conviction.
Correlations and dispersion, the difference in individual stocks’ returns versus the broader index, are rising. This is fertile ground for active managers to pick winners and avoid losers.
“Whether you’re a value picker or a growth picker, there should be a lot of opportunity,” said Bill Street, head of investments EMEA at State Street Global Advisors, which manages $3 trillion of assets, of which $2 trillion track indexes.
“Our mutual funds flow data suggests that at least in 2017 and in Q1 of this year, more funds were outperforming the benchmarks than not. Q1 has been very positive, our active funds have performed very well,” Street said.
Data from Morningstar paint a similar picture. Their figures show 43 percent of active U.S. managers outperformed their average passive peer last year, compared with 26 pct in 2016.
Internationally-focused funds did better still. About 55 pct of active funds in the “foreign large blend and diversified emerging markets” categories beat their passive benchmarks last year, up from 36 pct in 2016.
Demand for index-tracking funds, meanwhile, appears to be waning.
European-listed exchange-traded funds (ETFs) attracted inflows of just under $23 billion in the first half of 2018, according to Citi. Annualised, that’s roughly half of last year’s $90 bln net inflow. Flows were strong in January and February but have since stalled.
According to Blackrock, flows into European-listed exchange-traded products (ETPs) last month slowed to $533 million, the lowest inflow since December 2014.
Citi and Blackrock’s figures both show that flows into Europe and emerging markets dried up most - Europe actually posted net outflows - while the shining light in the gloom was persistently solid inflows into U.S. index-tracking funds.
But while flows into index funds are slowing, performance has been relatively good, especially once the fees charged by active managers are taken into account.
A report from S&P Dow Jones Indices shows that no more than 7 pct of domestically-focused U.S. equity funds beat their benchmark on a 5-, 10- or 15-year risk-adjusted returns basis last year. Performance was stronger in some areas, for example mid-cap value funds on a 5-year returns basis.
Internationally-focused U.S. funds fared better, with up to a third of overseas small cap funds beating their benchmark. But index-tracking funds were still overwhelmingly the better bet.
“On a risk-adjusted basis, the majority of actively managed domestic and international equity funds underperformed the benchmarks net of fees. We did not see evidence that actively managed funds were better risk managed than passive indices.”
And actively managed funds generally lag their benchmarks over time. Morningstar says the average dollar in passively managed funds typically outperforms the average dollar invested in actively managed funds. The ebb and flow of active managers’ relative success is “very noisy” over the short term.
This year has been more conducive to active investing. Volatility, political and economic uncertainty, fears of global trade wars and concern that the economic expansion and bull market may soon roll over have all risen.
As the gap between U.S. and European economic performance opens up, so too is the U.S. and European earnings gap. Estimates suggest Q2 U.S. earnings will grow around 20 pct year-on-year, and only 2 pct in the euro zone.
Emerging markets are buckling under the weight of higher U.S. interest rates and a strong dollar. Some, such as Turkey, are suffering domestically-generated problems too. All this throws up potentially rewarding, but risky, opportunities.
“Of course, there are active investors who outperform. Not most, and not half. But there’s a minority who do earn their fees, and they should continue to be in demand,” said Howard Marks at Oaktree Capital in his latest note to clients.
— The opinions expressed here are those of the author, a columnist for Reuters —
Reporting by Jamie McGeever; editing by David Stamp