Stock markets and uncertainty about the future: a chance for active managers

When the going gets tough, the tough get to play. It is on this saying, attributed to the American football coach Frank Leahy that he would have pronounced it for the first time in 1954, which is based on the hopes of “active” investment funds to beat the increasingly fierce competition of “passive” instruments, the so-called ETFs (Exchange traded funds). As long as the markets had a clear direction – is the reasoning of the supporters of active funds – it was possible to earn simply by investing in market indices, from those of the stock exchanges to those that replicated baskets of bonds or more sophisticated ones linked to specific themes. As the stock exchanges went up, interest rates dropped to subzero. There was no need to worry about creating active funds, which tried to beat the reference benchmark but at the price of higher costs, it was enough to follow the wave with the much cheaper passive funds.

The reason for success

This explains the reason for the great success of ETFs and their exponential growth over the last few years, especially in the United States where they have found favorable ground but, lately, also in Europe and Italy. In 2022 they reached 10 trillion dollars of assets under management in the world. In Italy last year they reached 120 billion euros. But the recurring question among insiders, the many fund managers who work hard every day to obtain returns, is simple: in recent years the world as we knew it has totally changed, first Covid-19, then high inflation and the new monetary policies, finally the war. And, in the background, the possible recession and perhaps the ghost of stagflation. In a world marked by so much uncertainty and highly volatile market trends, some believe that the time for active funds would be back.

“We are in a completely new scenario,” he says Giordano Lombardo, founder and CEO of Plenisfer Investments Sgr, which operates in the ecosystem of Generali Investments. “And in this scenario, passive managements give fewer guarantees of obtaining returns. For two substantial reasons: the first is that through passive funds you invest with what we could define the rear-view mirror. In fact, investing on market indices based on capitalization existing, the focus is actually on companies that have already been successful and therefore are already represented in the benchmark. Instead, the allocation of savings should be made with an eye to the future, identifying new trends and new opportunities for capital profitability . Especially now that the future seems structurally changed. Passive management works well with bull markets, not when we are faced with a radical paradigm shift as is the case today “.

The second limit, according to Lombardo, lies in the lack of an asset allocation. “ETFs and passive management in general do not respond to the issue of asset allocation, the heart of portfolio construction. They simply replicate indices defined by sector or country. Today, however, in a phase in which traditional asset classes are moving in parallel and negatively, the portfolio must also be able to include alternative asset classes and in any case get out of the logic of traditional asset allocation which may no longer work well “.

On the other hand, that of the large ETF producers, starting with the American Vanguard, it is pointed out that the search for positive returns by active managers is by no means a downward path and represents more an ideal than a real fact. Trying to beat the benchmark – or the parameter taken as a reference – to measure the so-called “alpha” (the extra quid in addition to what the market has done alone, photographed in the benchmark), is a rare undertaking. For twenty years, Standard & Poor’s has been comparing the performance of active funds with the benchmarks that are taken as underlying assets by ETFs. The recurring research is called S&P Indices Versus Active Funds, better known by the acronym “Spiva”.

The report on Europe

The latest report, relating to 2021, shows that in Europe, already in the one-year yield, the funds beaten by the benchmark are between 40 and 80% of the total (the only exception being Italy where only 32% of the 69% of the funds were beaten by the indices). But with increasing time in which performance is measured, the shares of active funds beaten by benchmarks grow, and in 10 years only a handful have managed to do so: for the S&P Europe 350 only 16.67%, while for the S&P Global 1200 less than 4% showed that active management yielded results. Equally shocking figures are also in the United States, where only 33% of large capital managers outperformed the S&P 500 in the three years to June 30, 2021. “In the end, the evidence suggests that active management has a high probability of getting long-term underperformance, “he says Mark Fitzgerald, Head of Product Specialism in Europe at Vanguard. Moneyfarm Chief Investment Officer Richard Flax shares the same opinion: “The data suggests that indices, in most equity regions, do better than most active funds over the medium to long term; secondly, it is difficult to consistently outperform. an index, just as it is rather difficult to select managers capable of doing it “.

That of teams trying to beat the benchmarks is a sore point. The stability of a management of this type is by no means assured in the medium-long term, because many leave or change their shirts. So it can happen that a family of active funds has a positive performance because a certain management works well but then this same team loses pieces over time. Beyond the team problem, there is also that of the “management style”: you can achieve good results for a certain period with a certain style but other styles and approaches will prove better over time.
Then, even more importantly, there is the problem of costs. Recent research by Vanguard itself would show that the main reason for the underperformance of active funds over the long term is to be found precisely in the costs: “The higher these are, the less the chances that outperformance can be generated. This explains the reason for the significant growth. that low-cost index funds have had in recent years “.

The controversy

However, operators tend to dampen the controversy. Both BlackRock (the largest manager in the world) and Vanguard itself have both active and passive funds. “These are two different tools but they coexist very well in the hands of those who build investment portfolios,” he says. Luca Giorgi, head of IShares and Wealth of BlackRock Italia. “But there is no doubt that ETFs are one of the biggest success stories in the asset management industry in recent years. ETFs, used wisely, allow you to lower the costs of managing a portfolio. And in Italy the latter they are slightly higher than elsewhere, in the face, however, of high quality or high added value customer service “.