The manager of Fidelity’s £2.9bn Special Situations fund has said the amount of money piling into passive strategies with a smart beta overlay has made the markets “dumber”, which is good news for investors of actively-managed funds.
Alex Wright’s two funds try to invest in firms which he sees as “intrinsically undervalued”, and which therefore arguably rival smart-beta exchange-traded funds which also look to find cheap stocks.
Smart beta strategies select holdings using certain characteristics in a bid to control risks and get targeted outcomes, at a cost that is generally lower than active managers.
“Clearly ETFs and smart beta strategies have been gaining a lot of market share over the past five years,” Mr Wright said, adding these strategies “clearly appeal” to some investors.
Such "programmatic" strategies are also used by a lot of active investors in the hedge fund world, he said.
But the Fidelity fund manager said ultimately this magnifies market volatility as these systems are pre-programmed to act in a certain way when certain things happen.
“Obviously if the whole herd of the market is pre-programmed to do the same thing at the same time, then it’s unlikely to be the right thing to do.”
Mr Wright claimed that was why there have been big moves in the market which “look a bit weird”, pointing out, for example, that in January the whole market sold off dramatically after being influenced by small shifts in global variables.
“To me this actually looked like a great buying opportunity and we increased the gearing of the fund.
“From an active investor’s point of view, I would say it is good news that the markets are actually becoming dumber, because there are lots of algorithm-based programmes running the money instead of smart fund managers.”
He said these programmes are based on what has worked in the past, which doesn’t necessarily continue to work in the future.
Mr Wright, who also manages Fidelity’s Special Values fund, said this increases volatility in the equity markets as a whole, which he argued is “difficult for some investors to stomach”.
“Yet this increases your ability to add alpha to the fund by taking advantage of those kind of moves.”
Over the past three years, the Special Situations fund has returned 25.3 per cent while its sector, the IA UK All Companies, has returned 13.7 per cent.
Ben Yearsley, investment director at the Wealth Club, said: "I'm not sure markets are necessarily getting dumber.
"Indeed there are times when owning the market is a good option, but I'm not a big fan of smart-beta or active tracking; it always seems an unsatisfactory halfway house."