On 16 December, we were joined by Jasper Thornton-Boelman (JT-B) from Parmenion, Toby Gibb (TG) from Fidelity International and Ben Kumar (BK) from 7IM to discuss active, passive and multi-asset investment approaches and their relative merits.
You can watch the show here.
We ran out of time to answer all the questions, so we asked our experts if they’d provide us with their answers and they did.
With markets across the world gradually becoming more integrated, with information more readily available and stricter regulation, are we moving towards a world of strong-form efficient market hypothesis? With this in mind, what does the future of active management look like?
JT-B: Whilst availability of information is undoubtedly high (and perhaps will become even more so going forward), the premise of EMH would be that funds are allocated based company fundamentals, news flow etc (essentially anything in the public domain that would influence the price) – I’m not sure this will always be the case, irrespective of information availability. If you consider the rise in Passive management, this is an inherently inefficient way to allocate money. This should theoretically create dislocations between prices and fundamentals and thus opportunity for Active management – so long as it isn’t an entirely one way trend for Passive.
BK: There is a counter-acting trend which also needs to be considered – the rise of passive investing. This means that more dollars than ever before have been allocated without the kind of analysis which strong form EMH requires. So while there is more information, fewer individuals are using it. We believe that there are likely to be long periods of passive dominance, which are shaken up by events. It is during these shake ups where active managers can be adding the most value – we saw it in 2020.
TG: I would agree that regulation, access to information/data and computing power have more of less eliminated any ‘informational arbitrage’ that might have existed in the past. But I do think there are other market inefficiencies that active managers can exploit.
There continues to be a significant opportunity to exploit the fact that the market takes a very short term view, tending to focus on next quarter’s earnings rather than the long-term fundamentals of a business. This creates a time horizon/analytical arbitrage opportunity. The point is demonstrated on the chart below. It shows how much the market tends to focus on the short-term and ignore what really matters – the long term.
The chart shows the average number of earnings forecasts globally and in different markets. The trend is very clear – the sell-side is very comfortable making predictions 1,2 and even 3 years out, but beyond that very little work is done. And this is where we can add the most value – by exploiting this time horizon arbitrage and focussing on the long term.
The next chart shows why this is so important. The scale here is months. Over the short term, share price performance is driven by changes in the price earnings multiple – essentially sentiment/noise. However, over the longer term, it is earnings growth that matters – company fundamentals and the structural growth trends they are exposed to.
By properly understanding the growth drivers of a company, it is possible to identify mispricings on a consistent basis. I would say that, if anything, the market continues to become more short-term focused.
There’s no doubting some active managers can and do outperform, but doesn’t all the evidence (SPIVA etc), point to it being almost impossible to pick these managers in advance and without the benefit of hindsight?
BK: It is possible to avoid OBVIOUS errors. Managers with high fees, low tracking error and low active share are obvious candidates to avoid. And then the next stage is to understand the philosophy of the manager you’ve bought, and their time horizon. On a one or three year view, it’s very difficult. But give your manager a decent time period – 5, 7 10, 20 years, and it becomes a lot more possible to see rewards from investigating. The classic example is of course, Warren Buffett. Over the past five years, Berkshire Hathaway has struggled – but over the long term, he’s still the greatest stock picker we’ve seen.