Global conditions have improved for active managers to outperform

Henko Roos (CFA, CIPM), Senior Fund Analyst at PSG Wealth.

The best reason for South African investors to gain offshore exposure is diversification. It offers various benefits, and specifically, access to sectors and industries that are not available in South Africa. A key benefit for investors using strong global active managers is their ability to navigate uncertain times and remove emotion from the investment decision-making process.

Over the last seven years, passive management has benefited from huge tailwinds, while active managers have had an uphill battle. However, a changing macro-economic backdrop suggests that active management could soon see a lift.

“For example, we have seen the early stages of a potential move from monetary to fiscal policy, mostly in the US,” says Marcel Roos (CAIA), Fund Analyst at PSG Wealth. “But there are clear indications that many other developed markets (DMs) are poised to follow suit. Additionally, we have seen rising inflation expectations in DMs combined with declining inflation in emerging markets (EMs). GDP growth estimates for DMs have also steadily been improving. “

The positive news for global investors is that markets are catching up to these fast-changing dynamics and this is reflected in the upswing of global corporate earnings, which supports equities. Historically, during periods of changing trends, active managers have had the best potential to find mispriced securities and outperform market indices, usually through accurate regional and sector allocation, as well as strong security selections. Against a changing backdrop, active managers may be able to add alpha in rising markets, while dampening volatility in down markets.

Improved outlook for global growth and increasing inflation expectations for developed markets
Various leading economic indicators are showing that global economic growth is on the rise.

While in 2016 the US was basically the sole driver of growth expectations, the increased positivity is now being driven mostly by non-US economies, which shows that the global economy recovery is broadening. There has also been an increase in inflation expectations in a number of key markets.

Luckily for global investors, markets are starting to catch up to these fast-changing undercurrents. This can be seen in the improvement of company earnings on a global scale, which supports equities. Most major markets, including broad emerging markets (EMs), have seen a noticeable increase in the estimates of their 12-month forward corporate earnings.

The move from monetary to fiscal policies

Over the last eight years, investors have become accustomed to the benefits of QE. However, more recently, there have been indications of a potential change in central bank policies, from monetary to fiscal stimulation. Central banks have indicated their intention to start normalising rates and tapering off QE as the recovery in the global economy continues to stabilise.

A further challenge to monetary policy could also come from the fiscal side. In the US, the Trump administration has indicated its intentions to focus on deregulation, tax reforms and infrastructure spending. Although it may be too soon to speculate on the exact scope of these plans, the intention to shift the focus to fiscal policies is clear. The gradual reduction of money supply, rate normalisation and fiscal stimulus create a changing macroeconomic backdrop that should benefit active managers.

Firstly, regional allocation should become more crucial as countries have different timelines for implementing the policy shifts. Secondly, sector allocation and bottom-up stock selection will prove valuable as these changes will have varying effects on companies based on the industries that they operate in and their balance sheet composition.

Convergence of emerging and developed market inflation rates

Marcel says he and the researchers noted earlier that there has been a steady increase in inflation expectations for developed markets (DMs). “At the same time, inflation rates in emerging markets are falling, and the gap between the two is now at its lowest level in at least 20 years,” he comments. “The falling inflation in EMs and rising inflation in DMs are adding to the appeal of EM investments. This causes an inflow of foreign funds into EMs and, in turn, protection against currency devaluations, despite the US’s tighter monetary policy.”

The favourable population growth in EMs and a move towards consumption and higher value-added industries, like technology, should provide investors with opportunities. Investment risks in EMs are also reduced due to their lower inflation rates and less risks to their currencies. EMs represent about 11% of the global MSCI All Country World Index. This presents good quality active managers with opportunities to overweight EM exposure to capture the upside potential in these markets.