Why an active approach to investing makes sense in changing market conditions?
I’ve never been one for making resolutions around Western or Chinese New Year but one promise I made to myself at the beginning of 2018 — and am doubling down on now that we’ve bounded into the Year of the Dog — is to be more active.
I’m not talking about pounding the treadmill; no, I’m referring to my investment strategy in a year that promises the return of volatility to the market after an extended period of some of the most boring markets (from a professional investor perspective) in a decade.
Extraordinary easy monetary policy from central banks has provided liquidity to the extent that markets have risen across the board. Funds that track the major indices have done the same. That has created a perception that investing passively in the index is essentially a risk-free bet.
Nothing could be further from the truth – because in volatile markets, blindly tracking the index with full market exposure can leave you nursing significant losses. An index tracking fund does very little to protect your investment when markets turn against you.
While we remain bullish on the economic outlook and on equity markets in general, we recognize that it’s a mistake to time a correction. It’s interesting to note that in the recent market downturn, the active institutional money effectively sat on the sidelines. By having an active component to the management of our portfolios we aim to limit the potential downside risk to our portfolios as well as to capture the upside.
As I mentioned in an article a couple of weeks ago, volatility also creates opportunities, even for long-term investors. Now is a good time to evaluate sectors and positions, and to increase those positions or add new ones at the right price when the opportunity presents itself.
Finally, volatility has a habit of separating the wheat from the chaff in the investable universe. If you take emerging markets for example, a passive approach may leave you exposed to a basket of index stocks with a high proportion of family and state-run enterprises where the interests of minority shareholders may not be the highest priority. That may be fine when markets are going up irrespective of fundamentals but finding the right, quality, companies to invest in can pay dividends over the long term.
We are quietly pleased that in 2017 – a year with very low volatility – our model portfolios significantly outperformed their target returns (see below).
Portfolio performance from 1 Jan 2017 to 31 Dec 2017:
Each portfolio is built around an actively managed Certificate provided by Banque Julius Baer, a leading Swiss bank, formulated in partnership with Morningstar, with the objective of returning optimal performance at every level or risk. They enable an active approach with a single, low and transparent fee structure and no hidden costs. They have the added advantage over a basket of ETFs of minimizing the effects of fee stacking.
What all this means is that in the year ahead, an enhanced approach to active management will remain important. It’s a strategy we’re doggedly determined to pursue.
The writer is a partner at Crossbridge Capital.