Will Active Management Make a Comeback ?
Rising dispersion in equity market returns could revive the fortunes of active fund managers according to Deutsche Bank analysts.
Last year experienced the largest gap between US active and passive flows according to Morningstar’s Global Asset Flows Report. The study said active US funds suffered an outflow in 2015, while passive US funds attracted inflows of $400bn (€355bn). “There has never been a larger gap between US active and passive flows. In 2014, for example, active flows were much smaller than passive ones, but they were still in positive territory. Not so in 2015,”said Morningstar.
This month in Konzept, Deutsche Bank Research’s magazine, Luke Templeman argued that rising dispersion, the spread between the returns of different assets, in equities could revive the fortunes of active fund managers. Templeton wrote that dispersion of returns between sectors in equity markets has almost halved leading to more homogeneous performance despite large variations in the fundamental performance and profitability of companies.
“Return on equity data show that high-return companies are improving further while low-return companies are deteriorating,” added Templeton. “The spread between the median return on equity for the top-quartile of companies and the median for the bottom quartile has widened by about 25% since the financial crisis.”
He continued that in the S&P 500, the gap between the ebitda margin for the median for the index and the median for the bottom quartile has widened from 12% to 15% over the past two years. “This divergence between fundamentals and stock market returns suggests that investors are ignoring the differences in the quality and earnings of individual stocks and are merely sharing their cash with companies relatively evenly,” said Templeton.
He added that reasons for this phenomenon include the flow of money into passive strategies as forced allocations prop up failing companies and investors’ obsession with dividends leading to companies maximizing their payments, even if not justified by their fundamentals.
“This situation has led to the dispersion of payout ratios across the S&P 500 hitting its highest level this century,” added Templeton. “Ditto for share buybacks. The $690bn in announced US buybacks over the last decade is half as high again as the previous decade.”
Dispersion has risen by one-fifth from its low at the end of 2014 as markets have become more stressed. Templeton said if this continues active management becomes more attractive as managers who pick the right or wrong stocks will be rewarded or punished more quickly.
“If the flows into passive funds begin to slow, the effects of increasing dispersion could magnify,” added Templeton. “That is because, in one sense, money held passively is akin to a reduced free float of a stock. So with proportionately more money trading actively at the margin, the volatility of share price returns increases.”
However the flows into passive strategies look unlikely to slow. Institutional investors have predicted that the global exchange-traded fund market will double in size over the next five years to 6% of global assets under management from 3%, or $3.137 trillion, according to research from European ETF issuer Source.
In the study just 9% of respondents expect to decrease their allocation to ETPs over the next 12 months while a third expects to increase their allocation. Source surveyed 55 institutional investors online this month.
Lee Kranefuss, chairman of Source, said at the Inside ETFs conference in Amsterdam: “We firmly believe that ETPs and ETFs should account for a far higher percentage of global investment fund assets under management, offering a highly competitive, overwhelming alternative to traditional investment vehicles and funds.”
In addition institutional flows into ETFs are projected to grow to an annual $300bn by 2020 according to a report this week from Greenwich Associates. The consultancy expects the increased annual flows to come from broadening use of ETFs across applications and asset classes ($132bn) ; the migration toward using ETFs to obtain core exposures and achieve strategic goals ($42bn); liquidity needs in fixed income ($68bn); the use of ETFs to replace derivatives positions ($28bn) and smart beta ETFs ($25bn).
Greenwich Associates expects ETF allocations to climb to 25% of total institutional assets in North America, 15% in Europe and 10% in Asia.
Andrew McCollum, Greenwich Associates managing director, said in a statement: “The results of the study suggest future growth of ETFs in the institutional channel will be driven by the continued discovery of new and more sophisticated applications for the funds across investment portfolios.”
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