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Is an active approach to equity management still valid?

21 February 2020

Global equity indices have moved higher despite the global impact Coronavirus is having and the threat it poses to supply chains and economic growth. Central banks continue to supply ample liquidity to markets and with interest rates low, equity markets remain attractive to investors. The US results season showed little growth in earnings, yet the market has performed well, led by the IT sector.   

As I write, the tech heavy NASDAQ Index is up 9.3% year to date, whereas the broader based S&P 500 Index is up only 4.7%. As indices have moved higher, the range of stocks contributing to the move has become narrower, particularly in the US market. In 2019 the US market was up over 30% but the top 25 contributors, (less than 5% of the names in the index) accounted for 43%* of this return.  So far this year the top 25 contributors have accounted for 74% of the return. Microsoft, Amazon, Apple, Tesla and Alphabet alone have contributed to nearly half the index return.  You do not need to hold all these stocks but if portfolios have had no exposure this year they will be struggling to outperform.  As these stocks become more highly rated, we need to make sure the potential growth justifies this.

With a more concentrated and actively managed portfolio, you may capture these from a narrower universe of stocks, but there is a danger that you miss it entirely. Historically, the average US equity active fund manager has underperformed the index as a whole. However, this increased dispersion of returns with fewer stocks is a double-edged sword that gives greater opportunities for a selective approach. Outside the US, with less tech exposure so far, performance has been spread more widely. As equity markets move higher, they are more likely to become volatile and returns may become more concentrated in fewer names. Against this background, manager selection will become more important than ever. In a multi asset portfolio of funds it will be important to look through the funds to make sure that portfolios remain diversified to avoid the situation where all managers are pointing in the same direction.

*Source Bloomberg,  Bloomberg US large cap index of over 500 stocks

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