Pension fund investors with US or UK exposure may have witnessed what appears to have been a remarkable recovery amongst their active fund managers’ performances of late. The fact that they have begun to outperform their benchmarks at long last seems to have caused such a flurry of excitement that it has led some in the industry to even go as far as proclaiming the end of an era for indexed funds. Others say, don’t believe the hype.
Over the past six months, actively managed funds certainly have been making noises in the markets which have been notoriously tough for them to beat. Around 69% of diversified US equity funds beat the S&P500 in the second quarter, according to Lipper Analytical figures, a far cry from the depressing numbers witnessed over the past couple of years where the levels of managers outperforming the index have dropped to as low as 15% in a given quarter.
Actively managed US equity funds have returned an average of 10.16% for the second quarter this year against the 7.06% returned by the S&P, says Lipper. And for UK equity funds, the six month sector average from the beginning of the year according to figures from Croydon-based Forsyth Partners was 11.7% compared to the FTSE which was only up by 9%. Two particularly shining stars were the HSBC UK fund which was up 19.7%, and interestingly, one of the industry’s favourite whipping boys - Schroders - whose ISF UK equity fund was up 19%.
The reasons behind this turnaround in performance seem sadly less to do with active managers developing fabulous stock picking skills (though many will tell you otherwise), but more to do with market conditions which are changing in their favour. “The FTSE is atrocious this year,” says Peter Toogood, head of research at Forsyth Partners. “It is so bad, it’s wonderful for active managers.”
Up until recently, funds which have not been invested in the small group of dominating large cap US and UK stocks have underperformed their benchmarks. And all the time the FTSE and S&P indices have been driven by these few stocks, active funds investing in these markets have remained in the doldrums.
In the European equity market, viewed as an easier market to beat, active managers have had less of a hard time, consistently proving their mettle. Over the past two years for example, the likes of Gartmore and Newton have comfortably beaten the FT/S&P World Europe ex UK index which returned 44% - Gartmore’s continental European fund returned 57% and Newton’s 66% (see below).
Now it seems the kinds of opportunities managers have found on the continent, are showing signs of being offered to them in the US and UK markets.
A strong signal in the US, is that small cap earnings have outperformed large cap earnings for the first time in six years giving stock picking funds more of an opportunity to shine.
“We are seeing incredible valuations in certain areas of the market at the moment, “says Brady Lipp of US fund manager Warburg Pincus in New York. “The value of some of these small and mid cap stocks are an all time historical low. When this market turns, you are going to see some dramatic outperformance.”
Active US equity funds of the moment include Luxembourg-domiciled Mercury ST North American fund in the US growth category which is up 17.41% over six months, and for value the GAM GAMCO vehicle is up 27% over the same period.
For small caps, Morgan Stanley’s fund, again Luxembourg-domiciled, was up 30% at the end of the second quarter. “You won’t have found many funds which have meaningfully outperformed the S&P500, “says Forsyth’s Toogood. “The sector average numbers for the US have been appalling, almost over any time period you care to mention except over the past few months. And that has been because value and small cap in the US has come back into fashion.
“This is the stockpickers’ opportunity. Index trackers are probably doomed for the rest of 1999.”
Frank Russell’s sustained faith in active managers is reflected in its 100% active multi manager products which do not even include so-called ‘active-passive’ strategies. Ken Ayers at Frank Russell in London is confident that investors will become increasingly disillusioned with indexed funds. The proportion of indexed assets in pension funds portfolios have grown significantly over the past couple of years and a decline in interest in the asset class could be imminent, he says. “There should be some limits to people’s enthusiasm,” says Ayers. “What might have already levelled off is people starting the whole RFP process for indexed_exposure.”
“I think it is a message which has seeped into people’s consciousness’ of too much indexation in the market,” agrees Gartmore’s Anthea Nugent, though on the subject of Gartmore’s own recent impresive performance, she is quick to add categorically: “But it is not that we got lucky.”
Crispin Lace at Watson Wyatt, however, does not see the immediate client prospects of active fund managers being affected at all and is cautious in his views that active managers will take assets away from their passive counterparts. “We will probable see a slowdown in the increase of money going to passive managers,” he says, but adds: “One sees times where it is difficult for the active fund management industry to outperform and then one sees times where it is less difficult for them. But it doesn’t impact on what you think about active fund managers.” Watson Wyatt will not be reviewing its Structured Alpha product either, which has a substantial passive core.
Active funds are tipped to outperform for at least the rest of the year, though it is too soon to tell just how long markets will stay in their favour. For the duration, while such fund managers will be expounding the true value of active fund management, pension funds are not necessarily advised to listen too closely , or at least to react too soon. “This is not about the fact that active managers were dumb and suddenly they got brighter,” says Michael Lipper at Lipper Analytical in New York. “This is a normal rotation – what is abnormal is what took it so long.” As such, while Lipper has seen some shifts in pension funds’ asset allocation over the past six months, the subject of indexation is by no means dead and buried.
“There are still very good reasons for people moving into index funds,” warns Anthony Ashton at Callan Bacon & Woodrow in London, “and one is risk control”.
Only a sustained longer term performance therefore is likely to sway pension funds from reviewing their asset allocation. As Toogood states, “The FTSE is still a tremendously powerful weapon over three years,” which of course also applies wholeheartedly to the S&P. “Tracking is not dead yet.”