So far, 2017 has been good to active stock pickers. This week I look at why and ask whether this year’s sweet-spot is set to last.
Why stock pickers are enjoying 2017 so far…
After a few recent years when passive funds have been on the rise, both in terms of performance and popularity, active stock pickers have had some good reasons to celebrate in 2017. So what is new this year and is this relative change of fortune set to last?
Reasons to be cheerful
According to Bank of America Merrill Lynch, 54% of large-cap active managers beat their benchmarks in the first quarter of this year and 60% did so in the second quarter. Whilst “just over half” may not sound stratospheric to some investors, nonetheless these figures represent some of the best performance for active styles of stock picking since 2009. What’s more, it has been achieved against a backdrop of very low volatility, which is usually bad news for active stock pickers.
Using the Chicago Board Options Exchange’s “fear gauge”, the Vix, as a guide to wider market volatility reveals a very quiet year (to October, the time of writing).
Low levels of volatility usually hamper active stock picking and favour passive vehicles (such as exchange-traded funds) that track the market. So what has been going right for active managers?
Three key factors
The first important factor that marks out 2017 as different to, say, 2016 is record low correlations. In essence, when correlations are low it means that there is a wide divergence between say a broad index such as the S&P 500 or FTSE All-Share and the individual stocks that make it up. This helps active stock pickers as it widens the gap between the best and worst performers and makes beating a broad index easier.
Next up is sector selection. 2017 has rewarded manager who, for example, have avoided sectors linked to the record low oil price and instead gone for faster-moving alternatives, such as technology.
The third key factor is what has been dubbed the “sideways market”. In 2016 the FTSE 100 came off lows in February around 5,500 points to end the year much higher. Anyone who simply tracked its progress over this time would have done well. This year, however, trackers have struggled to make any headway as the FTSE 100 has remained largely range-bound. This can be seen here;
The key question for investors is to what extent this mini-boom for active investing will prove to be long-lasting. Two factors could help to determine the answer. One is the growing preference of Central Banks, led by the US Fed, to withdraw monetary stimulus by increasing interest rates, reversing liquidity measures (“QE”) or both. If a rising tide of liquidity has been floating all boats, active or passive, in recent years, active stock pickers should benefit as it is withdrawn. The next factor, which could operate in reverse, is the tendency for more developed-market firms to seek funding away from conventional stock exchanges. If this US trend gathers momentum it will leave fewer stocks for active managers to select from and could dull their edge.
A closing word of caution
Whilst active managers have been enjoying 2017, be careful to make sure you are looking at risk-adjusted returns and not just the headline number the manager wants you to see. Watch out, for example, for hedge fund returns that reflect risk (gearing) as much as skill. Comparing apples with apples when it comes to performance is as important in investing as anywhere else!
Other videos to watch
If you’d like to see videos that explore some of these last ideas in a bit more detail, please go to www.Killik.com/learn and watch “Why is the US stock market shrinking?” and “How quantitative tightening may impact investors”. Finally, for more on risk-adjusted returns you could try “how to weigh up funds using the Sharpe Ratio”.