Coronavirus turns active management underperformance on its head

The coronavirus sell-off has turned active management’s long track record of underperformance on its head, at least for the short term, although investors are mixed on how defining the period of market volatility will be for fund managers.

According to FE Fundinfo figures referenced by the Financial Times, since 20 February 80% of UK mutual funds invested in US equities outperformed the market, while 89% of active UK funds outperformed. In European equities, 91% of active funds beat the market.

However, it noted active managers in Japanese and emerging markets had struggled to outperform their benchmark.

In contrast, the S&P Indices Versus Active Funds scorecard has repeatedly highlighted the majority of active funds are able to outperform indices over longer time horizons. In the 2018 report, 75% of UK active equity funds underperformed the index over a 10-year period, while 93% of active US equity funds underperformed the S&P 500.

Mainstream indices have fallen dramatically across the board in sterling terms since 20 February. The FTSE 100 has shed 27.3% while the Stoxx Europe 600 has lost 25.8%. The S&P 500 has dropped 16.4%, the MSCI Emerging Markets is down 15.4% and the Topix has lost 17.8%, according to FE Fundinfo.

Major index performance since 20 February

Source: FE Fundinfo

Dangerous comparison

But Square Mile head of investment Jason Broomer (pictured) says trying to compare active funds by using indices as a benchmark is “really quite dangerous” given how rapidly markets are moving both up and down. This is because most funds price at midday, whereas indices price at 5pm or close of business.

“There could be 5% difference there,” he adds. “One day actives might look very clever but the next day they’ll look stupid, purely on the back of the way the markets are moving.”

Active managers ‘desperate to salvage reputation’

But fees campaigner Robin Powell says for active managers to suggest that their performance over recent weeks is some sort of victory, or even a validation of the active approach, is “a mark of just how desperate they are to salvage their reputation”.

“True, some active managers have been able to reduce the impact of the market falls. But there are thousands of funds, and you’d expect some of them to outperform the broader market simply by random chance,” he says.

“Remember as well that most active funds include an element of cash or bonds for liquidity purposes. Equity index funds invest 100% in equities. That a particular fund has fallen less far then the index may simply be down to the fact that it was taking less risk.”

Powell says fund managers should be judged over at least 20 years, not 20 days.

Index investors ‘hostage to fortune’

Fairview Investing consultant Gavin Haynes says being in an index means being “a hostage to fortune” during market sell-offs. It is often the case when people are just looking to raise money, the first things they sell are the large liquid stocks so “indices get hit hard”.

He says the bull market of the past decade had provided a benign backdrop where buying beta through passive strategies was very fruitful, but we are now entering very different times.

“I do think this will prove to be a defining period for active managers,” he says. “It’s at times like this they can justify their fees. It’s impossible to avoid losses in these extreme environments, but it does provide an opportunity to defend clients’ money relative to index performance.”

Haynes believes this downturn has a similar feel to those experienced in the wake of 9/11 and the financial crisis, the effects of which took a further 18 months and six months, respectively, to bottom out. He says it feels like we’re in the ‘capitulation’ and ‘panic’ phases of the investment cycle with some equities already at record low valuations.

“You wouldn’t be selling into these these markets; valuations now are at extreme levels on some equities,” he says. “Although the problem is you just can’t quantify what the the ‘E’ of the P/E is at the moment because there’s such a lack of clarity regarding where earnings are going to be.”