Investment

Is it the right time for family offices to pick stock pickers?

Back in 2004, when the world was recovering from the dotcom bust, investors hailed the arrival of a bull market.

Edward Bonham Carter, former chief executive of UK-based Jupiter Fund Management, took a different view. He sensed the arrival of a hippo market – superficially calm, but with a tendency to lash out at bystanders when upset.

Active managers have performed better still in niche areas, where indices can be illiquid and poorly structured

Four years later, in 2008, the hippo threw a really nasty wobble and put the entire stock market in peril. This is what you get if you borrow too much from the banks to rebuild an economy. 

And as today’s markets steady after the pandemic to achieve an unstable equilibrium, the hippo is still out there. 

For now, however, according to an analysis by research firm Gavekal, markets are no longer dominated by uniform fears of economic collapse. 

A surge in growth stocks has run out of puff, to be replaced by broad economic recovery underpinned by low interest rates, profits recovery and a subdued rate of inflation. 

A strong correlation between stocks and sectors due to macro issues has ebbed away, providing stock pickers with a better chance to shine, after years on the naughty step. It helps that value stocks have staged a recovery, given the tendency of active managers to play safe, as they see it, by investing in them.

Analyst Tan Kai Xian of Gavekal says weak correlation is good news for stock pickers, as markets continue to grind higher, despite frequent hiccups. 

Data supplier Managed Portfolio Indices records the performance of managers who look after 130,000 portfolios for the wealthy. Over the last year, the majority of higher-risk multi-asset portfolios easily beat hybrid equity/bond indices. Even its medium-risk median came close. Which makes a nice change. 

Multi-asset funds run by other managers have also improved over the last year after a bit of fancy footwork in the bond sector, during its slump in the first quarter.

Returns for active equity funds are less problematic, following recent style changes.

Data from S&P shows that 60% of US large-cap active funds were beaten by the index in the year to December following a strong surge in value stocks, against 75% over five years.  

In Europe, no more than 37% of equity funds were beaten by the indices over twelve months, against 75% on a five-year view.

Active managers have performed better still in niche areas, where indices can be illiquid and poorly structured. According to data from Albemarle Street Partners, nearly 60% of European small-cap funds beat their index over five years.  Around 55% of global emerging market managers were ahead as was Asia Pacific, where indices are weighed down by banks, real estate and utilities. 

It’s too bad you need a great deal of skill, and a weak index, to be a successful stock picker in a market where outstanding returns are skewed towards a small number of stocks.

Unless you happen to be really expert on a sector, cheap passive portfolios are more likely to own the winners. And the majority of managers tend to spend more of their time avoiding losers, rather than finding winners, because they do not want to risk losing their clients.  And you never make as much from avoiding losers, as backing winners.

In his Alpha Beta blog Tony Yiu recently found that in a recent two year period, an equally-weighted portfolio of 570 US large-cap stocks would halve its returns by missing out on the ten biggest winners. Avoiding the ten biggest losers only improved its record by an eighth. 

Just as smart managers work hard to find the right stocks, family offices need to work really hard at picking managers. Consultant Willis Towers Watson has found that 30% of active managers are sufficiently diligent to rise above the fray by outperforming most years, net of fees. 

By using big data, and various vetting tools, WTW reckons it can raise the odds of outperformance from active investing to 50/50, after taking account of fees. 

At a time when indices, and their growth stocks, are groaning under the weight of earnings expectations, this may actually be the right time for family offices to try to pick stock pickers.  Maybe even the odd long/short hedge fund, given the hippos are out there.

This view on stock pickers would go against the herd, which pushed $246 billion into ETFs tracking US stocks in the first four months of the year against $231 billion in the whole of 2020.

But that doesn’t necessarily make it wrong. 

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