As the financial services sector of the share market heads back towards its 1980s share of about 10 per cent of total market capitalisation, compared with the peak of 40 per cent in 2006, one could be forgiven for wondering about the fundamental value proposition presented by banks, funds managers and insurers. It is well documented that funds managers as a whole do not add value; that’s why there are index funds. But a sufficient number do and their names change often enough for that industry to expand.
As has been famously said of banks: banking is essential, banks are not. And insurance companies clearly provide a service to smooth out risks but perhaps the price, especially in insurance of investment management products, is generally too high. The two main beneficiaries of the credit bubble, arguably exacerbated by Alan Greenspan, the former Federal Reserve governor, with his reaction to the bursting of the tech bubble in 2001, have been financial services and property companies. The two are closely linked.
The unreal spreads in the credit market, the unreal lending policies of some institutions, led inexorably to an unreal appetite for risk and unreal property prices. Investors, and indeed all Australians, can take some heart from the unusually statesmanlike speech by Glenn Stevens, the Reserve Bank governor, last month just prior to the extraordinary rescue package proposed by the Bush administration. Stevens said that the crisis would lead to a return to greater prudence, increased savings and reduced consumer expenditure – “living within our means” – and that would be good for the long term wellbeing of the economy.
While that may sound overly wholesome and simplistic for sophisticated market participants, a bubble is a bubble and a binge is a binge – they cannot continue indefinitely. A major irony is that funds managers contribute to bubbles. Active managers with an element of momentum in their style, which is possibly the majority of managers, will continue to buy as long as there is good ‘news’. Cap weighted index managers take their investors on the same ride. The irony is, though, that active managers can show their true worth in this sort of environment.
Research by Russell Investment Group shows up the cyclical nature of outperformance, or lack of it, by active managers. After a difficult 18 months, active Australian equities managers have again outperformed since September last year. This month marks the 21st anniversary of the 1987 share market crash and to a certain extent, markets have come of age since then. Peter Gunning, the global chief investment officer of Russell, told the firm’s annual conference in Melbourne last month that while active management relative performance was cyclical and managers tended to struggle in highly speculative environments, they also often rebounded strongly.