The endless debate passive vs. active.   I am yet to be convinced passive investing has now replaced active management as the gold standard, notwithstanding and possibly because this has become such a mainstream view.  i.e. the herd are investing zillions into passives over the last 5 years.

 

The answer is simple though; you should only pay for an active manager if the manager can deliver “alpha” i.e. provide a better return after fees than the market, otherwise simply buy the market i.e. the passive tracker.  I have heard of tracker funds, which cost as little as 0.05% – 0.10% per annum.  Fidelity even have a zero-cost tracker (they make their money by loaning shares to short-sellers).

 

The concern I have with passive investing is that passives are price agnostic, there is no price vs. value analysis underpinning the strategy.  Most trackers are still market cap weighted as the share price increases the share is either included or becomes a bigger part of the index notwithstanding that the share might be trading at euphoric premium price levels.  You are in affect buying yesterday’s winners.  There is another debate iro “smart beta” products or rules based investing, which use algorithms based on multiple factors to decide on the holding of the portfolio i.e. p/e, earnings growth, debt ratio ect… Ironically the decision of which passives to invest in is now an active strategy in itself.

 

NB!! Going back to valuation vs. price.  Investment returns are always about the price you pay when you invest.  Price is what you pay, value is what you get.  The price vs. value elastic can stretch for very long before it finally snaps, and the price then reverts to what the share is worth.  The problem is time and investor patience,  there is an old saying about betting against the market, which states that market can remain irrational a lot longer than you can remain solvent.  Short-term prices are irrational, and 5 years is a short-term when it comes to investing.

 

My concern is the recent proliferation of passive investments is based on a specific time period where we have seen unprecedented central bank intervention in the market in affect changing the rules of investing temporarily by allowing the elastic to be stretched further than in past cycles.

 

Well regarded investment disciplines have been disregarded because money was to cheap, simply buy what goes up and keep buying more while its going up, who cares what it is worth or what it costs i.e. bitcoin.  The chart below shows the relative performance of value investing as a strategy vs. growth / momentum, since 2008 and the GFC when we were introduced to QE and negative interest rates,  value investing, which is effectively active investing, has been smashed by growth / momentum strategies.

 

Markets have been driven up by cheap excessive liquidity.  See chart below.  The red line is a 50 / 50 equity / bond index portfolio and the blue line is central bank stimulus.

In December we saw the S&P 500 index fall the most since the great depression of 1929, basically because the Fed Governor Jerome Powell erred in saying that “rates were a long way from neutral” just when the US economy was starting to slow. Had he uttered those words when US growth was still accelerating, investors would have probably disregarded them.

 

Powell will not make the same mistake again and we have seen him do a completed about turn with his current dovish tone, it now appears the master has become the slave to markets and the market loves the idea that Powell has it back, which probably explains why we have seen such a strong 1st quarter, perpetuating the chart above by pushing the S&P500 even higher notwithstanding what is clearly indicative of an expensive market getting more expensive.

 

The problem is Powell’s sensitivity to the market is likely to see the Fed fall behind the curve and then must play catch up with US interest rates, this could be then be the inflection point for value / active investors.  Only time will tell.  The problem is not calling the bubble, rather calling the endgame.   For me now is a time to stick with value / active investing and the fact that the herd is throwing in the towel on active is a contrarian indicator that we are nearing an inflection point.   Unless investing is now for the computers….

 

The current dislocation in the market where expensive gets more expensive and cheaper gets cheaper can continue for a long time until it doesn’t…….

 

Mark Williams
Mcomm, CFP®, HdipTax
T. 021-851 3746
Email. service@synfin.co.za

 

 

 

 

 

 

 

Market may be nearing inflection point
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