Is it time for a more active approach?

27 March 2020

8 minute read

When the Dow Jones Industrial Average index of leading American companies slumped to 23,553 on March 11, a stock market record was broken1.

The fall in US equity valuations was the fastest slide into a bear market, plunging by over 20% in 20 trading days from its peak on February 12 fuelled by panic around the world over the COVID-19. Previous falls of the same magnitude have taken almost a year on average. The second fastest fall was in 19291.

On 12 March 2020, the FTSE 100 index of Britain’s biggest companies recorded its biggest one-day fall since 19872. It had seen more than half a trillion pounds wiped off its value in the previous weeks.

The falls on markets might prompt investors to reconsider the benefits of a more active approach to investing. Those fully exposed to the market using passive investment tools are nursing heavy paper losses for March.

The economic and market impact

As of March 27, over 500,000 cases have been recorded of coronavirus around the world since it was first reported by Chinese officials on December 31, and nearly 25,000 people have died3. While new cases in China have slowed, the US and much of Europe are expecting a rise in casualties over the coming weeks.

As numerous possible treatments are being studied, governments have sought to control the spread of coronavirus, and manage the impact on healthcare services, by forcing businesses to close and demanding that people stay indoors.

Forecasting the full impact of these shutdowns is nearly impossible as a lot will depend on how long such measures remain in place. The Federal Reserve Bank of St. Louis President, James Bullard, has suggested that the unemployment rate in the US may jump to 30%4, while some economists predict that UK GDP may contract significantly. This is expected to be short-lived with economic activity returning gradually to normal towards the end of the year.

Gerald Moser, Managing Director and Chief Market Strategist at Barclays Private Bank, says: “In modern history, we have never seen major national economies suffering such a sharp downturn at the same time. The global economic shock is likely to be bigger than anything we have encountered before, but it is also likely to be followed by an equally sharp recovery.”

The scale and rapidity of equity market falls have caught investors off guard, leading them to seek shelter in cash and pressuring share prices even further. Encouragingly, while markets are expected to remain volatile, the bulk of the selling pressure may now be behind us according to several market indicators. “It’s likely that we’ll see a U-shaped recovery in markets. We are now in the base of this U, waiting for some clarity to start a rebound,” says Moser.

Despite signs of indiscriminating selling, driven by fear more than reason, not all sectors and asset classes have reacted in the same way, creating opportunities for those taking an active approach.

Indeed, amid widespread volatility, some pharmaceutical, technology and retail stocks have risen over the last month, while others have fallen only marginally. Other asset classes are also attracting investors who believe lower valuations are an opportunity to buy into longer-term trends.

The benefits of an active approach during periods of uncertainty

Investors who typically track an entire index through passive exchange traded funds (ETFs) or index funds at low costs are exposed to the full effect of the recent market rout.

Passive investing has been gaining ground on active management for two decades, fuelled by a surge in popularity of exchange-traded funds (ETFs), which are traded on a stock exchange like shares. The amount of assets in index-based funds and ETFs exceeded those in actively managed funds in the US for the first time last year.

But the collapse in equity markets raises questions about how investors can shield themselves from losses, and take advantage of potential opportunities, using a more active approach.

Active managers attempt to outperform the returns of a specific benchmark using analysis, research and proven investment processes to make informed decisions. In theory, this could protect investors from volatile markets, reducing the impact of market falls while providing opportunities to outperform. That said, research suggests that many active managers struggle to do this successfully.

One way an active manager could try to outperform a specific index is by holding more defensive sectors in falling markets or selling those most likely to lose value.

Julien Lafargue, Head of Equity Advisory at Barclays Private Bank, says: “If investors hold a passive ETF that tracks the S&P 500 at the moment, they are effectively making an active decision to own all the companies and sectors in that index. That means owning airlines, hotels and energy companies at a time when these companies are fully exposed to the impact of COVID-19.

An active manager that is genuinely active can make key decisions not to own companies that are most in danger. Indeed, they can adjust their weightings to different sectors in the market as frequently as they want.”

Some active managers merely mirror the market that their fund is benchmarked against, limiting the benefits of an active approach in bear and bull markets. Meanwhile, managers who run portfolios more actively are more likely to outperform during these periods, according to some studies.

Research by Invesco in 2017 looked at 3,000 equity mutual funds over the past 20 years.5 The research found that 60% of funds with a high active share, a measure of their difference to the index that they are benchmarked against, beat their benchmarks (after fees) across all market cycles studied on an asset-weighted basis.

In reality, a combination of active and passive strategies is likely to perform better over the longer term, according to Lafargue. “While some heavily researched and developed markets leave little room for active managers to add value, others are more suited to an active approach,” he suggests.

“A mixed portfolio of passive and active strategies can be the most effect way to meet your investment goals adjusted for your risk appetite, while reducing costs.”

How Barclays Discretionary Portfolio Management could help

At Barclays Private Bank, we give you versatility and a choice of services to suit your goals and approach to investing.

Our Discretionary Portfolio Management team builds and manages a portfolio of investments on your behalf. They take into account how much you have to invest, the level of risk you are prepared to take, your financial goals, and your tax position.

This includes:

  • A dedicated portfolio manager will invest on your behalf
  • Constant oversight to make sure your portfolio is re-adjusted during times of market volatility
  • Comprehensive range of multi-asset class solutions, as well as single-asset class strategies across equity and fixed income
  • Bespoke or modelled portfolios diversified to manage risk efficiently.

Discuss your needs and find out how we can help you achieve your goals. Contact your Private Banker.

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