Give yourself a chance to beat the market
David Prosser on the potential benefits of active management.
The Bank of England’s Deputy Governor is a bear on global stock markets. Sarah Breeden told the BBC that with many markets at or close to all-time highs, despite risks such as the Middle East war and the headwinds facing the global economy, the Bank is expecting “an adjustment at some point”. The Bank is on high alert to deal with the fallout from such a shock, she added.
Breeden isn’t calling a crash or trying to predict the timing of any correction. But you can see her point. It is hard to square a record high for US stocks with the chaos caused by the ongoing closure of the Strait of Hormuz. And it feels odd for UK share prices to be only 5% below their previous peaks despite UK companies’ exposure to the global economy – and the International Monetary Fund’s warnings that we are especially vulnerable to an energy price shock.
If the Bank of England’s anxieties prove well-founded, passive funds will, by definition, follow the market down.
David Prosser
Against that backdrop, it was fascinating to read an interview in Portfolio Adviser with Simon Gergel, who runs The Merchants Trust, the UK Equity Income investment trust. The fund’s track record is impressive, with good total returns, 44 years of consecutive dividend increases and a yield of close to 4.8%.
Gergel didn’t duck the question of whether the UK market’s strong gains in recent times were difficult to justify, though he pointed out there is still a perception that UK equities are less attractive than some of their international counterparts. Rather, he argued that performance has been highly polarised – a handful of sectors, including defence, oil and gas, have driven the market higher, while areas such as building and construction have been relatively lacklustre.
This polarisation is evident in other markets too. The US, notably, has been buoyed by the ongoing strength of big tech, as well as stellar returns from energy and financials. Other areas of the market have been weaker, held back by concerns such as rising inflation.
For Gergel, such divergence creates opportunities. He sees a chance for Merchants to invest in UK companies that remain undervalued given their long-term prospects. He said construction is a happy hunting ground given the desperate need to build more housing and to renew our crumbling infrastructure.
The broader point here is that Gergel is talking about an active approach to stock picking and fund management. The challenge he has set himself is to identify the likely value stories of the coming months and years, rather than to trust that a rising tide will float all boats.
Arguments about the merits of active investment, as opposed to passively following markets via an index-tracking fund, are as old as the hills. Do you trust Gergel and his like-minded peers to find enough of those stories, or do you prefer to buy the market as a whole?
At times like now, passive funds feel especially at risk. Market polarisation inevitably increases passive investors’ weightings towards those sectors of the market that are outperforming, while leaving them short on potential value plays. And if the Bank of England’s anxieties prove well-founded, passive funds will, by definition, follow the market down.
Investors should continue to take a long-term view, adjusting their approach according to their goals and their attitude to risk. However, if you share the Deputy Governor’s concerns, a passive fund feels like an uncomfortable place to be right now. And while there are no guarantees, an actively managed investment trust at least has a chance of beating the market – and confounding the Bank’s warning.
