The prevalence of index funds creates an opportunity for concentrated active managers to garner higher returns as the outlook for broad equity markets flattens.

While a growing number of investors have favoured low-fee, passive index and exchange-traded funds (ETFs) in recent times, active managers are expected to show their worth in the next five years, as monetary policy normalises and the global economy reflates.

This is the view of BT Investment Management head of global equities Ashley Pittard, who set up a concentrated global fund 18 months ago to take advantage of changing equity markets he believes will be “very different” over the next five years.

“We’ve all been very lucky in this industry for the last 15 years and we’ve been paid when it’s been a positive index for the vast majority of it,” Pittard said.

Now, many of the tailwinds that boosted major indices have turned to headwinds, meaning investors should expect more subdued returns from broader equity markets in the years ahead, he warned. In response, he added, investors should be positioning themselves with concentrated active portfolios.

“We need to think about how we allocate our global portfolios,” he said. “It’s a perfect time to be a contrarian.”

Pittard made his comments at the Investment Magazine Fiduciary Investors Symposium, in Healesville, Victoria, November 13-15, 2017.

He predicted flatter equity returns would be triggered by the “three Rs” – reflation, regulation and rotation − meaning economies remaining strong, regulators targeting dominant market players and central banks starting to wind back their stimulus spending and passing the baton from monetary to fiscal stimulus.

Tasplan head of listed investments and strategy Mark Williams said equities offered more value than bonds, but raised concerns about passive investment flows and the rise of ETFs “feeding a bubble”.

He noted inflows of $US1.4 trillion ($1.83 trillion) into passive funds since 2007 and the fact ETFs now account for more than half of all trades on the US market.

The failure of fee-charging active managers to beat the market in recent times has fueled the rise of passive strategies, raising the risk of a bubble occurring and potentially creating distortions in the market, preventing accurate and efficient allocation of capital, Williams said.

“Because of the sheer weight of money, it’s almost become a self-fulfilling prophecy that continues to drive up the larger stocks,” he explained. “The demand for stocks only fuels the price further and this can be exacerbated in stocks with large inactive shareholders, because there is less liquidity.”

Williams said 70 per cent of Tasplan’s global equity allocations were managed in concentrated, active strategies, while 30 per cent was invested via “enhanced passive” strategies.

“Overall, we made the move about 12 months ago to a lifecycle strategy and increased allocations to equities. We think there’s some way to go in the market with low inflation,” he said. “We still do favour equities over bonds but we don’t find either class particularly cheap and in equities we favour emerging markets over developed markets.”

Pittard and Williams agreed that asset owners with multiple active strategies need to manage the potential for these to cancel out one another and leave an aggregate performance in line with the benchmark.