Six reasons why now could be the era of the stock picker
2022 was an annus horribilis for active funds, where expert stock pickers sift through a market to construct a portfolio of the best stocks it has to offer. According to investing broker AJ Bell’s Manager versus Machine report, after fees just a quarter (27%) of active funds beat their passive equivalent, in which stock market indices – the benchmark against which active funds are compared for performance purposes – are simply copied.1
It comes hot on the heels of a decade of investors shifting into passive strategies. In the US, where much of the global stock market resides, 10% of total assets in US mutual funds was allocated to passive strategies at the onset of 2010; by the end of the 2022, it was 25%.2
The allure is simple: while there’s zero chance of outperforming the market, passives offer investors the opportunity to access stock market returns for very little cost and drag on their returns.
Since 2022 however, long-term market conditions have been evolving, as we move into an era where inflation and interest rates are likely to be structurally higher, and stock market volatility elevated for some time to come. It’s changing the playing field for stock pickers, and begs the question: as markets become choppy and unchartered, could now be the time to consider an experienced captain to navigate your investments through the storms?
Here are six reasons why the era of active may have arrived.
All aboard
1. Inflation and slowing economies create stock market winners and losers
Last year we saw sharply rising interest rates alter the relative values investors were prepared to pay for shares. This year, the driver of stock markets may shift towards newsflow surrounding company profits. Given that high inflation and slowing economies will hit company profits in varying ways, it implies a wide range of stock returns is likely.
It points to a need to separate the troubled companies that face existential threats, from those with a brighter future. Human stock pickers will be able to find companies that can navigate a tricky trading environment by identifying qualities such as strong pricing power, profits and profit markets, and low levels of debt.
2. New investing ‘styles’ come into vogue
In the decade running up to 2022, stock market returns were dominated by a handful of mega-sized technology businesses, particularly in the US. This trend may be about to go into reverse for an extended period: the winners of the last decade may face continued selling, and areas of the market that had stagnated in the former market regime may do much better, for example cheap ‘value’ stocks. Given the new market order, winners are likely to be found in various corners of the market, and it will take a discerning eye to find them.
3. Profits likely to fade for some companies
For more than a decade, globalisation, low inflation and cheap money spurred an era of ever-higher profits for companies, and now they’re looking vulnerable. As economic growth slows and costs rise, profits are likely to become increasingly squeezed, which may affect share prices. Experienced stock pickers will be needed to find companies that can sustain profitability.
4. US loses its dominance
In the former market regime, US markets outperformed non-US markets in eight out of the past ten years, largely on account of its heavy weighting towards popular ‘growth’ stocks. In the new regime, given that inflation is impacting countries in varying ways, a global investment approach, with asset allocators who can direct portions of the portfolio’s cash into different markets depending on how the economy is being impacted, will be needed. You won’t find this with passive strategies.
5. Volatility makes for a stock picker’s paradise
We need shares if we are to beat inflation, and yet stock markets are likely to remain volatile. According to data from index provider MSCI, stock volatility is above average in all major regions across the globe, bar Japan.3
Big differences in stock valuations, mean stock pickers can find cheap companies that have a chance of performing strongly over the long term, while avoiding those that appear overvalued and expensive. What’s more, the last two occasions when variations in stock valuations were as wide as they are now, were the tech bubble at the dawn of the millennium and the global financial crisis – following both periods, active managers went on to do well.4
6. Fee hurdles reduce
Passive funds are cheap by design, and the impact has been to drive down fees across the whole industry, including active funds. As a result, active managers find themselves having to leap over a smaller hurdle of fees, when comparing their performance to the index.
In contrast, some passive funds are proving costlier than they should be. According to research from Telegraph Money and Morningstar, charges can range from 0.5% to 1.5%, which is more expensive than the average actively managed fund.5
As fees for the two strategies converge, the cost benefits of passive strategies are fading.
It needn’t be tempestuous
Journalists and commentators have long indulged in ‘active versus passive’ debates, often portraying the rise of passives as stoking an existential fight between two sides of an industry. In truth, many investors appreciate that it is not an either/or situation – our portfolios are likely constructed best through a combination of both.
That said, in a bygone era of cheap money and low interest rates that raised markets more broadly, passive had been favoured. Since 2022 however, higher inflation and interest rates are changing the status quo, with markets becoming a choppy sea of winners and losers. So an experienced captain is likely required. Enter the era of the stock picker.
Alliance Trust
Alliance Trust is a highly active portfolio that utilises the best ideas of nine teams of stock pickers investing in markets across the globe, aiming to find strong long-term opportunities and provide both capital appreciation and a growing dividend for generations of investors.
Marcus De Silva, Freelance Investment Writer
1. https://www.ajbell.co.uk/sites/ajbell.co.uk/files/Manager_vs_Machine_July_2022.pdf
2. Hargreaves Lansdown; as at 20/01/23
3. https://www.quiltercheviot.com/news-and-views/articles/active-anticipation/?Region=uk&Role=fadv
4. https://www.quiltercheviot.com/news-and-views/articles/active-anticipation/?Region=uk&Role=fadv
5. Sunday Telegraph, 05/02/23
This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at April 2023 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
TWIM is the authorised Alternative Investment Fund Manager of Alliance Trust plc. TWIM is authorised and regulated by the Financial Conduct Authority. Alliance Trust plc is listed on the London Stock Exchange and is registered in Scotland No SC1731. Registered office: River Court, 5 West Victoria Dock Road, Dundee DD1 3JT. Alliance Trust plcis not authorised and regulated by the Financial Conduct Authority and gives no financial or investment advice.