Will active investing make a comeback?

Thought of the day

A record USD 433bn net inflow into exchange traded funds (ETFs) this year through September leaves little doubt why fund managers are keen to tap into enthusiasm for passive investing. Last week Legal & General Investment Management (LGIM), the UK’s largest asset manager, acquired ETF provider Canvas, providing it with 17 ETF products.

Even as it moves into ETFs, LGIM on 21 November stated that it intends to build its active business, which we believe makes sense for a number of reasons:

  • Active strategies typically outperform when rates are rising. In the US, during the past three rate-hiking cycles over the last 20 years, long/short (+13.4%), event-driven (+11.4%), and relative value (+8.3%) all exceeded returns for the S&P 500 (+7.6%) on an annualized basis.
  • Thirteen-week correlations between S&P 500 stocks of 8.6% are at decade lows and far below the 25-year average of 17.5%. From 2000–2016, equity long-short strategies generated average annual alpha of 6.5% or more when correlation was lower than the median.
  • While S&P 500 stock price dispersion is currently low, valuation dispersion between the cheapest and most expensive stocks is very wide. This suggests price dispersion could rise substantially if investor focus shifts to valuations – creating an attractive environment for equity long-short hedge fund strategies.

Returns to active management already appear to be picking up: in the first half of the year, 54% of US active managers surpassed their benchmarks. So we believe hedge funds have an important role to play in a balanced portfolio.

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