Late-Cycle Volatility and Active Management

October 2018

bfinance insight from:



Justin Preston

Senior Director, Head of Equity, Public Markets

In bfinance’s recently published Asset Owner Survey, just over half of investors expressed the belief that market conditions over the coming twelve months should favour active equity manager performance versus passive strategies while only 10% disagreed. As rising rates and geopolitical tensions rock global equity markets, we ask: is active management back in favour?

Around the world, asset owner sentiment is now dominated by late-cycle tensions. Among our clients, this has translated into demand for diversification, not just beyond equities but within equities (emerging markets, small cap et al). The climate has also driven a notable increase in appetite for explicit downside protection strategies involving overlays.cd

Yet a recent survey of 485 asset owners globally suggested another potential beneficiary of the current climate: active equity management. 51% of the respondents, whose combined assets approach $8 trillion, believe that active manager performance should be favoured during the coming phase of the cycle, including 60% of those in the Nordic&Benelux region and 59% of those in Australia&New Zealand; only 10% disagree.

 

Meanwhile, 12% of respondents (16% in Canada) intend to move towards active equity management in the coming year, swimming against the current that has prevailed through the past decade. While this may seem like a modest figure, it represents an interesting shift in industry dynamics – especially combined with the softening appetite for further movement towards smart beta and passive management.

It is worth noting that the regions where investors are most likely to expect outperformance do not necessarily represent the regions where investors are most likely to shift towards active management. This is illustrated in the charts below, which display a selection of geographical subsets (in total comprising more than 80% of all survey respondents).

 


Source: underlying data for bfinance 2018 Asset Owner Survey. The eight regions displayed here represent >80% of total investor data. (not shown: Africa, MidEast, Asia, other European countries). For more data, see the Asset Owner Survey or contact the bfinance team.


Source: underlying data for bfinance 2018 Asset Owner Survey. The eight regions displayed here represent >80% of total investor data. (not shown: Africa, MidEast, Asia, other European countries). For more data, see the Asset Owner Survey or contact the bfinance team.

 

ESG and Active Appetite

Aside from performance expectations, the study also revealed another factor which may support appetite for active management through the coming years: ESG. 45% of investors believe that “good ESG integration” requires an active, as opposed to a systematic or passive, approach, while only 19% disagree.

This finding is particularly notable in light of the significant rise in the number of new passive or systematic products that claim to integrate ESG factors beyond negative screening, supported by increasingly sizeable sources of “ESG ratings” data, and the high profile efforts made by passive managers to increase their engagement efforts. Investors, it seems, are far from being entirely convinced by these ESG labels.

Source: bfinance Asset Owners Survey

Interestingly, the contingent of investors that associates sustainable or responsible investing with active management is strongly tilted towards larger institutions and those in regions where ESG is more likely to be considered a “high priority”. 58% of investors with over $25 billion in assets believe good ESG requires active management, as do 55% of those in Europe and more than 60% of those in Australia.

Even more interestingly, those same subsets of investors are also considerably more likely than average to have moved towards smart beta in the last three years, according to the same survey, indicating a high degree of awareness and sophistication when it comes to the systematic, passive-like options available.  

Turbulent Times

When examining past downturns such as the GFC, the TMT bubble and the Euro debt crisis, we certainly do not find that active equity managers as a collective group have managed to beat falling markets: some were able to protect plenty of value; some fell even more than the markets. The majority of recent manager selection projects for bfinance clients have placed an explicit focus on identifying managers who have shown an ability to protect value historically and understanding the reasons why. 

We will be keeping a close eye on manager performance data as it emerges during the coming weeks, to identify how active equity strategies have really coped with recent upheavals in global equity markets, and to determine the extent to which that performance has been driven by factors (e.g. value), fundamental stock-picking or the proportion of the portfolio that had been moved into cash.

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