All investment should rest on deliberate decisions, including consideration of risk.
Image: File picture: James White
By Richard Oldfield
To start with, my cards are on the table: I run an investment business where we charge fees for the decisions we take with clients’ money.
So you will not be surprised that I am a fervent believer in the value of active investment management.
I also see value in “passive” or tracker investments, which can offer low-cost, broad portfolios that passively mirror the make-up of market indices such as the MSCI World or the S&P500. There is a place for these. In 2014 Warren Buffett famously advised that his wife’s money should go into a tracker fund, and I’d agree: everyone’s pension or ISA should probably contain some passive holdings as a source of cost-effective diversification.
I do not agree, however, with those who claim that passive investing – which has grown hugely in recent years – will ever remove the need for active investment oversight. Active investing, where decisions are underpinned by fundamental research, is key to effective “price discovery” – the process through which markets attribute value to assets.
All investment should rest on deliberate decisions, including consideration of risk.
Right now, we are at a pivotal point where the trade-offs between cost, risks and returns need to be reconsidered. The composition of today’s markets, and the forces that are shaping companies’ future profitability, mean the dangers posed by passive portfolios – specifically, investors drifting into unintentional risk-taking – have rarely been greater.
Major indices are increasingly dominated by fewer stocks, from fewer countries, in fewer industries.
The US stock market currently makes up 74% of the MSCI World index, the highest degree of index dominance for at least 55 years.
This concentration is echoed lower down, with the ten largest US stocks making up 37% of the US market. Even during the late 1990’s tech bubble the top ten barely exceeded 25% of the S&P, so today’s level of US concentration lies outside investors’ experience. And of course, today’s largest holdings all represent the same, one-way bet – on US technology.
This phenomenon is not only about the US and tech. It’s happening in other regions, industries and indices too. It poses risks for all investors, and it requires an active approach to manage it. Markets move fast: to maintain a deliberate, planned exposure you need to be agile.
Price and value are not the same: if you choose a global tracker fund because you’ve heard it’s the cheapest way to invest, you also need to know – and sleep happily each night knowing – that a lot of your money is being invested in a handful of companies, all engaged in related industries.
Uncertainty is a constant in my world. I never come to work thinking uncertainty has gone away.
But in the years ahead we’re facing seismic shifts at both a market and macro-economic level. Increasing globalisation was the theme for most of my life to date, but now it’s stalling as protectionism and populism cause trade and political ties to fragment. Again, bond yields fell for the best part of four decades, but now they are rising again.
The market is changing in the way it responds to signals. Trump’s pronouncements, for example, whether they’re executive orders or tweets, are not necessarily moving stock prices: the market is discrediting what in other periods would have been clear signals.
In this environment investors need to be agile and armed with an understanding of how real policy outcomes will impact corporate valuations. That rests upon analyses of businesses’ operations, and only active managers undertake that work and can capitalise on it.
Passive investing is necessarily backward-looking.
The stock position in a passive portfolio is warranted only by what has gone before. Active investing can consider predictable future risks over the medium and longer-term, such as climate.
We devote significant resources to understanding climate risks and opportunities because we need deep knowledge to guide the investment decisions that get the best returns for clients.
The impact of AI, as it cascades out across industries and societies, presents similar scenarios.
There is another way in which active investors can drive returns: by encouraging the companies they own to adapt to trends which can undermine or strengthen their businesses.
The knowledge we build of the companies we invest in gives us perspectives and relationships that are critical to this engagement. Again, it’s costly, but it’s aimed at unlocking value for investors and is something passive funds are not equipped to do.
Oldfield is Group CEO of Schroders.
PERSONAL FINANCE