The cycle has now turned, and a lot of that money has left the market, and the opportunity to outperform has expanded,” Rogers says. “The combination of fewer players, more uncertainty in the economic environment and dislocation in prices cyclically sets up significant opportunities.”
Intech’s Needham lists four factors which combine to make the current situation look good for active managers: return dispersion is above average and this is historically associated with higher excess returns valuation spreads are very high the cycle has moved from low breadth of market to above average breadth of market, and earnings expectations are below average, which means it is as good an environment for growth managers as it is for value managers.
Some observers, however, are not easily taken by the talk of opportunity. “Stock-pickers always say it’s a stock-picker’s market,” Gray says. “But macro issues – to get them right and hedge against them – are more important.” In a research note to clients, Ross and other quantitative GSJBW analysts urge institutions to buy more risk
through specialist active strategies, such as small-caps, and exploit peak levels of valuation dispersion among securities. Showing conviction, the analysts assert: “We believe that equity markets currently lack the efficiency that would justify passive allocations”. It is not the time to load up on beta, Ross says. “There will still be a lot of stocks in the ASX200 that are sub-investment grade – active managers will add as much return from avoiding bad stocks than picking good ones.”
The GSJBW analysts say the median active manager of Australian equities returned about 1.5 per cent more than the benchmark in the current downturn, and about 75 per cent cleared the index, as top-quartile managers delivered, on average, 5.5 per cent of alpha. They earn their performance fees. And by avoiding poor stocks while price dispersion is so amplified, they will continue to do so.
GSJBW sees the price dispersion amid the best and worst-performing shares as a proxy for the opportunity set available to active managers. In 2008, this gap widened to its greatest since 1992. These wide spreads between stocks represent major inefficiencies that, if played right, provide good returns. In this market, “fundamental analysis of a company’s returns and ability to stay in business are more important than ever” for active managers.
Due to deleveraging and revisions of corporate earnings, an “abundance of mispricing opportunities” lies in the Australian market. And there are more corporate casualties, and therefore stock-specific risks, to come. “We favour more tracking error than less in an environment where we expect to see above-average levels of default by current index constituents,” GSJBW says. Specifically, quantitative managers, who suffered in 2008 as markets delivered and earnings revision signals proved unreliable, should benefit from the withdrawal of offshore hedge funds and proprietary trading desks, leaving room for survivors and entrants.
