By Mike Abbott, Head of Wealth of the Sable Group
Few roles are more mythologized than that of the financial investor. Some people, we are told, are blessed with a Midas touch and anything they invest in turns to gold. And for a newcomer to the industry, surely it’s obvious that some experienced investors are able to make better, more informed decisions than others? Not at all, many argue. Critics believe that since many active fund managers charge significantly for their services,they would need to consistently outperform the market in order to make it worthwhile retaining them.It’s worth remembering that with the bulk of global investment being done by professional money managers, any market out performance is in fact a manager beating his peers at their (zero sum) game of choice. Interestingly, statistics from Denys Glushkov confirm that active managers are on track to record their worst year since records began, with 90 percent of large-cap managers under performing. The sad truth is the much lauded money ‘masters’ aren’t living up to the ideal.
The “Efficient Market Hypothesis” illustrates the difficulties faced by the money manager trying to justify his fees.The ‘market’ is the average of all the decisions made by all the money managers and private investors. Being above the 50th percentile in the performance charts requires consistent outsmarting of your peers. But this is hard to do consistently over time. Mean reversion is a powerful force – powerful enough to suggest outperformance looks more like luck than skill.In a paper entitled “Scale and Skill in Active Management”, Robert F. Stambaugh, Luke Taylor and Lubos Pastor illustrate how the size of a manager’s fund hampers his attempts at outperformance. In effect, if he is successful, his success ultimately hampers his performance.
Further research by the State Street Centre for Applied Research identifies the effect of the knowledge economy on the skills of the money manager. As a money manager’s absolute skill level rises his relative skills level is actually falling. This is simply because 90% of the world’s data has been produced in the last 2 years. The information ‘edge’ that the professional money manager had is eroding fast. He’s playing a zero sum game and his only advantage is better information. This is the ‘paradox of skill’ as explained by Stephen Jay Gould in his study of baseball.
An awareness of this issue is what is driving so many people to adopt a “passive investment strategy”. Instead of seeking out winning stocks you “go with the flow” of the market, investing in a mathematically calculated range of stocks that reflect the market as a whole. Your portfolio will rise and fall with the index you are investing in.Passive investing has obvious advantages –the most obvious being the lower costs. This may be why there has been a recent surge of interest in passive investment: index-linked equity funds in the US had attracted $1.7 trillion by the end of 2013, adding $114 billion from the previous year.
Nonetheless, on closer inspection passive investment itself faces a number of challenges. The fund must still define the index and decide on whether to opt for physical or synthetic replication of the index and whether sampling is to be used. Replication of a very large index in physical form is very hard to do and will result in large tracking errors. So as a result most tracker funds with physical replication tend to track large developed market indices where liquidity can be assured. These logical constraints make passive funds more available in some investment sectors and geographies than others. The job of getting full global exposure without neglecting small caps or emerging markets is hard to do.
It’s therefore clear that both “active” and “passive” investments have constraints. But can one combine the flexibility of the active investment model and the cost effectiveness of the passive strategy?Surprisingly, the academic sector has been developing such approaches for many years but it’s only in the most recent decades that these strategies have been tested in the market place for real. Theory is getting tested in practice and the results are very encouraging.This approach (called smart beta by some) focuses on investing globally and passively and tilting the portfolio toward known elements of higher expected return (as demonstrated by research). Hence you have a passive investment strategy with an active evidence based overlay.
The inspiration for this approach comes from finance academics, Eugene Fama and Kenneth French.In their research they have identified two dimensions of known out performance, namely the ‘small cap premium’ and the ‘value premium’. In 2012 Robert Novy-Marx added a third dimension known as the ‘gross profitability premium’.The ideal fund, then, would seek to track such elements.This is where things get tricky. The real value add is in the design of funds that manage to get global passive exposure while incorporating these out performance ‘premia’. This has to be done at a cost that does not negate the benefits of these said ‘premia’. Fama’s theory is much admired, and it landed him the Nobel Prize in 2013.
All of these different options can be confusing. Which way should investors go? The temptation to try to be Warren Buffett and make your fortune by outperforming the market is undeniably a powerful one. Behavioural economists such as Daniel Kahneman would tell us we are hard wired to try. But before you embark on this strategy, make sure you’re not being taken in by the myth of the brilliant investor. The evidence suggests he might not exist. Any fund manager’s attempts to be one risks exposing your money to the wrong side of the mean. Whatever your decision, this is certainly a debate that should be raised. If you don’t, you’re selling yourself short.
Energy stocks drag down FTSE 100, IG Group slides
By Shivani Kumaresan
(Reuters) – London’s FTSE 100 slipped on Thursday, weighed down by falls in energy stocks as oil prices slid after a surprise increase in U.S. crude inventories, while IG Group tumbled on plans to buy U.S. trading platform tastytrade for $1 billion.
The blue-chip FTSE 100 index lost 0.4%, while the domestically focussed mid-cap FTSE 250 index also slid 0.4%.
Energy majors BP and Royal Dutch Shell fell 3.2% and 2.5%, respectively, and were the biggest drags on the FTSE-100 index. [O/R]
“What is holding back the UK is a lack of tech stocks to capture the ‘rotation’ back into tech seen since Netflix results,” said Chris Beauchamp, chief market analyst at IG.
“Stock markets overall are much quieter today, looking so far in vain for a new catalyst for further upside.”
The FTSE 100 shed 14.3% in value last year, its worst performance since a 31% plunge in 2008 and underperforming its European peers by a wide margin, as pandemic-driven lockdowns battered the economy and led to mass layoffs.
British Prime Minister Boris Johnson said it was too early to say when the national coronavirus lockdown in England would end, as daily deaths from COVID-19 reach new highs and hospitals become increasingly stretched.
IG Group tumbled 8.5% after announcing plans to buy tastytrade, venturing into North America after a stellar year for the new breed of retail investment brokerages.
Ibstock jumped 7.3% to the top of the FTSE 250 after the company said fourth-quarter activity benefited from better-than-expected demand for new houses and repairs.
Pets at Home Group Plc rose 2.2% after reporting an 18% jump in third-quarter revenue, boosted by higher demand for its accessories and veterinary services as more people adopted pets during lockdowns.
(Reporting by Shivani Kumaresan in Bengaluru; editing by Uttaresh.V and Mark Potter)
Wall Street bounce, upbeat earnings lift European stocks
By Amal S and Sruthi Shankar
(Reuters) – European stocks rose on Wednesday after Dutch chip equipment maker ASML and Swiss luxury group Richemont gave encouraging earnings updates, while investors hoped for a large U.S. stimulus plan as Joe Biden was sworn in as president.
The pan-European STOXX 600 index closed 0.7% higher, getting an extra boost as Wall Street marked record highs.
All eyes were on Biden’s inauguration as the 46th U.S. President, with traders betting on a bigger pandemic relief plan and higher infrastructure spending under the new administration to boost the pandemic-stricken economy.
Tech stocks rallied to a two-decade peak in Europe after ASML Holding NV rose 3.0% to all-time highs on better-than-expected quarterly sales and a strong order intake for 2021.
Meanwhile, Richemont rose 2.8%, after posting a 5% increase in quarterly sales as Chinese splashed out on Cartier, its flagship jewellery brand.
Britain’s Burberry jumped 3.9% after it stuck to its full-year goals, saying higher full-price sales would boost annual margins, while Asian demand remained strong.
The pair boosted European luxury goods makers that are heavily reliant on China, with LVMH and Kering gaining between 1% and 3%.
“Any sign that retail spending is picking up in China is going to be a boost to the Western markets and those heavily exposed to it,” said Connor Campbell, financial analyst at SpreadEx.
The European Central Bank is set to meet on Thursday. While no policy changes are expected, the bank could face more questions about an increasingly challenging outlook only a month after it unleashed fresh stimulus to bolster the euro zone economy.
“With the new round of easing measures fully in place and no new forecasts to be presented tomorrow, it should be a fairly uneventful day for the euro,” ING analysts said in a note.
Italy’s FTSE MIB gained 0.9% and lenders rose 1.6% after Prime Minister Giuseppe Conte won a confidence vote in the upper house Senate and averted a government collapse.
Conte narrowly secured the vote on Tuesday, allowing him to remain in office after a junior partner quit his coalition last week in the midst of the COVID-19 pandemic.
Daimler AG jumped 4.2% after its Mercedes-Benz brand unveiled a new electric compact SUV, the EQA, as part of plans to take on rival Tesla Inc.
Germany’s Hugo Boss added 4.4% after Mike Ashley-led Frasers said it boosted its stake in the company.
(Reporting by Sruthi Shankar and Amal S in Bengaluru; Editing by Shailesh Kuber and Arun Koyyur and Kirsten Donovan)
Miners lead FTSE 100 higher on earnings cheer
By Shivani Kumaresan
(Reuters) – UK’s FTSE 100 rose on Wednesday as miners gained after a strong production forecast from BHP Group, while encouraging updates from luxury brand Burberry and education group Pearson drove optimism about the earnings season.
BHP Group Ltd climbed 2.8% after it forecast record iron ore production for fiscal 2021, helped by high prices for the commodity. Other miners Rio Tinto, Anglo American and Glencore rose more than 2%.
Global markets rallied in anticipation of more fiscal spending as Joe Biden prepared to take charge as the 46th U.S. president.
“There is a view in the markets that more spending is in the pipeline, after all, Mr Biden will want to start his presidency on a positive note,” said David Madden, market analyst at CMC Markets UK.
The FTSE 100 index rose 0.4% and the domestically focussed FTSE 250 index added 1.4%.
The FTSE 100 has recorded consistent monthly gains since November after the sealing of a Brexit trade deal and hopes of a vaccine-led economic recovery, but has recently lost steam as tighter business restrictions sparked fears of a slow rebound.
Burberry rose 3.9% as it stuck to its full-year goals and said higher full-price sales would boost annual margins and Asian demand remained strong.
Global education group Pearson jumped 8.6% after its global online sales grew 18% in 2020, helped by strong enrolments in virtual schools.
WH Smith Plc surged 10.4% to the top of the FTSE 250 index as its trading during Christmas was ahead of its expectations.
(Reporting by Shivani Kumaresan in Bengaluru; editing by Uttaresh.V, William Maclean)
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