OpinionJun 2 2021

Active is coming back into fashion

Search supported by

Prior to 2021, it is fair to say diverse portfolios had to work harder for their returns.

Global markets were driven higher primarily by exciting, and ultimately riskier, technology companies as the world moved to a new environment following the pandemic.

In the US in particular, just a handful of companies have provided the vast majority of returns over recent years, as businesses have exploited the low interest rate environment and consumer and corporate demand for innovative solutions. 

The divergence that we have seen for the past few years is no longer as strong

This has consequently resulted in index-based strategies doing well, igniting the age-old question of which is better: active and passive management? Interestingly, the tide may be beginning to turn in this argument. 

As is often the case in markets, the picture is much more nuanced, but certainly during the first quarter of 2021 we are seeing advisers turn back to active strategies as the recovery plays out. 

Active fund managers have performed well of late, with the majority of equity funds outperforming their relative index in seven of the 10 major Investment Association sectors during 2020.

This performance has carried over in 2021 too, as the broadening of returns continues. The divergence that we have seen for the past few years, driven by US tech, is no longer as strong or a binary factor. 

As a result, expected growth rates across asset classes are trending lower. In some cases, the return expectations for this year are half what they were in 2020, and as such advisers and their clients have a choice: either take the index return or look for something different to generate extra value.

Despite the lower expected returns, opportunities remain across regions, although the pandemic has highlighted more than ever the K-shaped recovery that we will see (the companies that will survive and thrive versus those that will either struggle or fail). 

This does appear to be resulting in more demand for active strategies this year as clients are seeking to avoid some of the challenging sectors that are apparent when you look at the broad indices. 

Indeed, advisers, on behalf of their clients, are asking a lot more about exposures to cyclical areas that could benefit from the reopening and pent up demand coming through in the shorter-term, reflation trade.

That is not to say passive does not have a place in a portfolio; just under the stewardship of an active portfolio manager who can use them more tactically.  

Equally, given the headlines that we have seen regarding bond yields, advisers are concerned about what this means for lower risk portfolios – if you are using a passive solution, these past few months will have been a challenging period. 

Instead, traditional portfolios need to evolve with the market conditions and look for alternatives that can offer a good, but diversified, risk-return profile compared to traditional assets.

Fixed income will continue to struggle should the recovery play out as expected and as such clients will need something a little different if they are to succeed in a broad market environment. 

We have already seen this play out to an extent, with the latest IA figures showing February saw a return to active flows outpacing tracker funds, with much of this activity happening in the fixed income space as investors look for more flexible mandates. 

It is clear, therefore, that diversification is going to play a greater role in the recovery than it did in the lead up to the pandemic.

With bond yields rising and concerns about inflation spikes refusing to go away, investors are now being rewarded for holding a more diversified portfolio and managing the risks that are becoming increasingly present in the market. 

With the recovery ongoing and markets remaining uncertain, advisers will increasingly turn to active to capture as much of that rebound as possible.

Danny Knight is head of investment directors at Quilter Investors