Where next for 2018?

Financial pundits from fund managers to investment bankers know what to expect in the run-up to Christmas: it’s the time of year when they’ll be asked to make predictions about the performance of world markets over the following 12 months. It’s pretty much the only time they are forced to make such specific market calls.

This year’s forecasts make interesting reading – what’s most noticeable is their diversity. In the UK, for example, looking at a collection of predictions from 27 banks, fund managers and stockbrokers, their estimates for end-2018 values for the FTSE 100 index range from 6,500 to 8,600, a remarkably wide range that spans significant losses and strong gains. The experts’ views about other markets and asset classes are similarly lacking in consensus.

This reflects a genuine feeling in some areas that world markets are now at a crossroads. In recent years, for the most part, we have seen correlated and positive performance from assets all around the world, largely courtesy of the huge support pumped into markets by central banks co-ordinating monetary policy through ultra-low interest rates and quantitative easing. Now, however, monetary policy is diverging: the US and the UK have begun tightening policy while the eurozone and, in particular, Japan are further behind in the cycle. In which case, it’s reasonable to expect market returns to diverge too.

What does this mean for investors and their advisers? Well, one important implication is that it might be time to question whether the headlong rush into passive investment management makes sense. This trend has been accelerating: last year, Morningstar says investors put more than four times as much money into passive funds that simply track an index as active funds that seek to outperform. No wonder: in a market environment where the tide of monetary policy has floated all boats, why pay additional charges to an active manager whose job is to sort the winners from the losers?

Still, as Warren Buffett so famously remarked, when the tide goes out again, you get to see who has been swimming without a costume. That should be when active managers start earning their money – we’re paying them to keep us away from these costume-less losers.

There is some evidence this is already beginning to happen. Data from the asset management company Lyxor shows that getting on for two-thirds of actively-managed funds beat their respective indices during the first half of 2017, a far greater proportion than in 2016. By extension, this means they outperformed the passive funds too.

The usual caveats about past performance apply, of course, particularly given the very limited time periods under consideration. Nevertheless, there is a genuine case to be made for active management in the market conditions we now seem to be moving into – certainly a much stronger case than in recent times.

For the investment companies sector, this is good news. Closed-ended funds are almost universally active; they’re also much less prone to the accusation of closet tracking – their managers have a stronger record of conviction investment, as opposed to building portfolios that closely resemble the benchmark.

The other factor in favour of investment companies is cost. Charging, after all, is a major factor in the rise of passive management – investors reason, perfectly sensibly, that paying a premium for active fund management over a low-cost tracker is difficult to justify given the statistically poor chances of securing outperformance. Investment companies, however, have generally been cheaper than their open-ended counterparts – and many have cut fees significantly since the retail distribution reforms of five years ago that shook up competition in the marketplace.

Will 2017 prove to be the year we finally reached peak passive? Active managers will certainly hope so and the mood genuinely seems to be shifting in their favour at last. If so, bet on investment companies to reap the rewards.