Picking and choosing: Active management as an investment belief

3rd May 2022

A look at how active management can help create positive client outcomes

In February, Meta (formerly Facebook) crashed 25% – or $200 billion – in one day , the largest single day fall in the history of the US stock market, by market value.

More recently, a similar situation occurred for Netflix, where shares fell dramatically after it revealed its first ever quarterly drop in subscriptions.

With these big falls, one question to consider is whether these businesses genuinely lost a quarter of their intrinsic value overnight to match the share price drop? If not, was the company correctly valued before or after the fall, or somewhere in between?

According to James Courtman, Head of Equities at St. James’s Place: “Human beings play a major role in financial markets, and we’re prone to behavioural biases. And it’s these behavioural biases that create mis-pricings. And that’s as true today as it was during ‘tulip mania’ and in the 17th century Dutch Republic.”

Tulip mania refers to a period in the 1600s, where the prices of recently introduced tulip bulbs exploded over several years, before collapsing. It is often considered an early example of a pricing ‘bubble’.

For savvy stock pickers, these inefficiencies, or mis-pricings, provide the opportunity to outperform the market, by finding companies that are undervalued, and avoiding companies that are overvalued.

What are active and passive strategies?

Active managers are those who, through careful research and analysis, pick and choose the companies they invest in. This is different to passive strategies, which look to cover the whole market by tracking a given index. One of the advantages of active management is it allows fund managers to identify cases where they believe the market has misvalued a company and invest accordingly.

An active challenge

The reality is that outperforming the market is incredibly difficult in the long-term, and many active managers simply don’t add value. When we think about designing our offerings, this is always an important consideration, and we put a lot of work into locating the best managers in the industry.

According to Courtman: “There are certain behaviours and features of active managers that will increase the odds of being able to add value through time. We’ve really designed our approach around both of those points, taking into account the outside view that it’s very hard, and the inside view that there are certain things that you can do or prioritise that will improve your odds of success.”

To help with this, we have a dedicated, experienced team researching and selecting managers, as well as managing portfolios. And once we have constructed a portfolio of funds, we continually monitor its component parts and the wider strategy, to check if anything needs updating or changing. We believe that strategic asset allocation is the primary driver of investment returns, so continually and actively research and monitor the market environment to make sure you’re optimally positioned for the road ahead.

Even the best active strategies in the world will inevitably underperform as some points in time. This underperformance is not indicative of a lack of manager skill or poor long-term return prospects, especially over short horizons. Therefore, it is important to take a long-term outlook, when considering managers.

You don’t have to choose between active or passive management

There is a lot of debate around the strengths and weaknesses of active and passive investment styles, with some swearing allegiance to one style or the other.

The choice doesn’t have to be so binary. There is a gradient between the two – from simply tracking an index through to an individual, or team, manually picking a concentrated number of stocks they feel will provide the best returns over the long term. In our fund range, we employ a range of strategies across the active-passive spectrum as we feel that a blended approach can benefit investors.

Different strategies will have their own advantages and disadvantages.

However, in periods when markets are turbulent or falling, a good active fund manager may be able to make choices to help generate a positive return in a negative market.

Frederic Tache, Head of Fixed Income at St. James’s Place, notes: “Whenever you think about financial markets, the most important thing really is to avoid losing money. If you’re investing into passive, you take the decision that you will be exposed to every single crystallised loss appearing in the index that you try to replicate. Whereas if you’re ready to pay for active management, and you do your homework to make sure that your manager is doing this thoroughly, and as it should be, this is actually a strong way to reduce this risk as much as possible.”

While we believe active management has an important part to play in generating positive long-term returns, we use the full spectrum of investment strategies as and when we believe other strategies can support the overall portfolio strategy or complement our active fund managers.

A good example of this is our Global Equity Fund, which we refreshed last year. The fund has three strategies: two are actively managed, and the third is a passive strategy that is bespoke to SJP. This helps create a diverse pool of investments, reduces costs, and allows for the potential to out-perform the market.

Focussing on active management, but blending different strategies across different asset classes within funds and Portfolios, while using our scale to lower fees, we believe gives us the best chance of generating long term returns and creating good client outcomes.  This is the fourth article exploring our seven investment beliefs. The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select, and the value can therefore go down as well as up. You may get back less than you invested.

1Stocks fall as Facebook parent company Meta plummets 25% | MarketBeat
2Global Markets Weekly Update | T. Rowe Price (troweprice.com)