Click here to read our full coverage of the Morningstar Investment Conference.
There is more to equity funds than value and growth, Justin Abercrombie, Schroders’ Head of QEP Global Equities, kicked off his presentation at the Morningstar Investment Conference by saying. He went on to highlight quality-share funds, which look for profitability and financial stability, and for thematic investment, which limit the investor’s universe to a particular geography or a sector. Out of these, quality has been a good friend to value investing in the long run and has been particularly helpful in times of market downturns, Abercrombie said.
In what Abercrombie calls the “Quant Shock of 2007/08”, investors seemed to have forgotten about quality, he said. Risk models basically told us you didn’t have to worry about it: models from 1989 to 2007 were built on the notion of high correlation between value and quality and thus dismissed the need to own the latter. This, however, was a short-term view and the relationship between the two is shaped more like a see-saw over the long term. That’s why Abercrombie said managers were “missing the picture” in the 2007-2008 period. The industry also appeared to confuse the role of quantum momentum and to rely excessively on it.
Abercrombie turned to minimum volatility portfolios and showed the audience how their returns are inversely related to market performance. Noting that average alpha in a touch lower than normal at present, Abercrombie asks the question: Where has the alpha gone? Over the past 15 years, if you bought minimum volatility stocks, they were cheaper than the market, he says, so this strategy had an additional valuation benefit. During the market crash, however, defensive and less volatile stocks were more in demand and thus began to look expensive. All in all, Abercrombie points out that comparing current to past minimum volatility portfolios is not comparing apples to apples, and over the long run this approach is perhaps “too good to be true.”
Where does active management come in this story? Abercrombie looked at market performances over the past decade and identified episodes of “high breadth” and “low breadth,” the difference being that in a high breadth market more companies are advancing than declining. High breadth markets are characterised by active managers usually adding value, especially those picking value stocks, he added. Interestingly, growth managers prefer low breadth markets because in such a market environment, the growth themes are more accentuated and therefore more easily identifiable.
Abercrombie tried to demonstrate to the conference audience that, ultimately, the real skill of an active manager is knowing how to play the game when market returns is not enough. Periods of “moving away from equilibrium” create ‘fat pitch’ opportunities and at the moment, he sees potential fat pitches the financial crisis (“is it really over?”), in emerging market dispersion, and in the switch from cyclicals to defensives.
In conclusion, Abercrombie’s market outlook includes the thoughts that, since QE2, returns from style investing illustrate a one-dimensional, risk-on market. Cyclical stocks were “the buy of the century” in 2009 but have since then priced in the recovery, and in the current rising rates growing market environment cyclical sectors, which led the market growth previously, are performing poorly, while healthcare, tech and energy are outperforming.
