Do investors need active management?
11 JUL, 2023
By Alex Stanić, Head of Global Equities at Artemis and co-manager of the Artemis Funds (Lux) - Global Select.
Active investment managers are often criticized for performance and costs. Equity funds that mirror the make-up of major indices like the Euro Stoxx 50 of major Eurozone stocks or the S&P 500 index of US equities are undoubtedly cheap at as little as 0.1% a year. So why would you pay as much as, say, 1% a year for a typical actively managed fund?
There are hidden benefits to active management. If you want to hold companies to close scrutiny, ensuring transparency on the board, prudent pay for executives, and positive movement towards better environmental standards, you are more likely to get this with an active manager.
An active manager may deliver similar or only marginally better performance than a passive fund, but it is important to look at volatility, too. You may find that over the long term, the actively managed vehicle gets you to a similar destination but with a much smoother ride.
This is important if you get investor travel sickness – and many people do. They see their investments take a tumble, and a remarkable number sell in panic – missing out on the recovery. Then there are the forced sellers – those in retirement, for example, who rely on their investments for income and have to sell units each month, irrespective of whether markets are up or down.
Down markets can be very painful for them, as they must sell more units when markets fall to maintain their steady income. This undermines their portfolio’s ability to recuperate when markets bounce back. An active manager can rarely avoid downturns completely, but they may protect investors from the worst of any market fall.
There are many risks in the market at the moment. The worst is the bubble building in some of the mega-cap tech stocks. A passive fund has to buy the constituent parts of the index and cannot avoid these, even when prices become stretched.
Take the S&P 500, which is up 16.5% this year and nearing all-time highs. This looks impressive, but just six giant stocks – Apple, Alphabet, Amazon, Meta, Microsoft and Nvidia – have risen 80% this year. Remove these stocks from the index and the S&P’s returns look rather tepid. Yes, these big tech stocks – especially Nvidia – are seeing some positive earnings momentum behind them, but is it enough to sustain such a rally?
Apple – up 53% this year so far – represents nearly 8% of the index. That is a lot of exposure to a stock that looks overpriced by most measures. We can – and do – avoid it. Microsoft is nearly 7% of the S&P 500 index. We hold it, but it is only 3% of our fund.
Of course, not holding or underweighting these stocks when they are on a gallop means there will be periods when you underperform. Investors need to expect that. But the dictionary of clichés has many phrases to cover this experience – like “losing the battle but winning the war” or, turning to Aesop’s Fables, the tortoise and the hare.
I prefer a sporting analogy. Being able to avoid or underweight companies that are pricey and vulnerable to correction is like playing golf and carefully avoiding the bunkers. You might have to play a bit more cautiously, and on some holes that will cost you, but over the course of a long game you are less likely to find yourself kicking up the sand and trying to get out of trouble.
History shows that between 2000 and 2003, when the tech crash saw indices plunged by around 40%, many actively managed funds fell by just 20%. That amount of capital protection left savers much more money in the market to enjoy the bull market that followed. Remember, if you lose 40% you have to generate 66% to get back to where you were. If you lose 20% you have to generate only 25% to recover.
We encourage investors to invest in equities for the long term – 10 years or more. It is over the long term that we should judge the performance of active managers. I am happy for my long-term performance to be interrogated. The teams I have worked with have generated strong outperformance by investing selectively. Yes, there have been poor patches, but over time the strategy of buying quality companies with good growth potential at a sensible price has worked for investors – not only in terms of returns but also in terms of volatility. It has been a more comfortable journey, too.
You don’t always get what you pay for, and I will be the first to admit that this is often the case in active management. But choose good managers – with good records, decent teams behind them, and a sensible approach to investment – and I believe you shift the odds in your favor.
