A question of style

The Review examines likely trends and future changes in investment styles in light of the pandemic
by Dan Atkinson


The Covid-19 pandemic has changed the landscape in so many aspects of life, from government financing and work patterns, to interest rates – or the lack of them. But what is likely to be the impact on the different styles of investment, a question inextricably bound up with the perhaps more pertinent issue, for investors, of which styles are likely to be most fruitful in this radically different climate?

Long before anyone had heard of Covid-19, there was much debate, sometimes fierce, about the different investment styles on offer, such as whether active investing is better than passive, or whether value stocks are superior to growth stocks. In the further reaches of this debate, the question of what constitutes ‘smart beta’ – essentially passive investing and, depending on who you talk to, either involves some discretionary human activity or the pursuit of maximum diversification – is discussed.

Another cross-current before the pandemic was the increasing demand for responsible finance, including environmental, social and governance (ESG) related investments, overlapping with ‘social impact’ investing. Will this be sustained in the colder climate of the post-pandemic economy, one in which unemployment, public deficits and taxation may well increase, while interest rates could remain at rock-bottom levels?

Active versus passive

Perhaps the best place to start is to look at how the active versus passive debate is likely to play out on the other side of the Covid-19 crisis. Active investment is best defined as the traditional ‘stock-picking’ approach, with human skills and judgement employed to uncover the best opportunities. Passive investment is based on the notion that markets efficiently incorporate into prices all the information available at any one time about the assets being traded, thus trying to ‘buck the market’ is futile. It’s better and cheaper simply to buy all the stocks in a particular index.

Roger Jackson CFP™ Chartered MCSI, director of financial planning at UK-based Financial Management Bureau, is fairly certain that the pre-virus trend towards less expensive passive investment will be accelerated. “The days of the active managers who claim to be able to outperform the market are limited, or even numbered,” he says. He adds that during the pandemic “active managers have not been delivering”, meaning that the already existing scrutiny of costs is now taking place at a time of underperformance, thus the move into passive investment will be magnified.
"The FTSE 100 index is essentially backward-looking and contains a fair number of ‘losers’ from the virus"

“Whether that is a good thing is another matter,” he continues. “Passives buy assets when they are expensive and sell them when they are cheap, so there may be a tendency to inflate values.”

One effect of the crisis will be to make investors more aware of the different types of passive investment, according to Darius McDermott, managing director of Chelsea Financial Services, a fund research specialist with a long-established client list. He says the twin concerns about the cost and performance of active management will not go away, but the virus has shown that not all benchmarks are equal: “For example, the FTSE 100 index is essentially backward-looking and contains a fair number of ‘losers’ from the virus, such as airlines. By contrast, the S&P 500 index has done well, not least because it contains a large number of ‘winners’ in the tech sector.”

Rob Morgan, pensions and investment analyst at wealth manager Charles Stanley, sounds a warning note about the current success of passive investing in the S&P 500, noting the dominance of tech giants. “We are asking if that is a stretch too far and whether it involves a concentration of risk. What could be future regulatory action against these companies, such as anti-monopoly measures?”

Peter Sudlow CFP™ Chartered MCSI, principal of Sapienter Wealth Management, says: “It is plausible to suggest that disruptive events such as the current situation would cause some investors to reassess their situation and switch from active to passive investment or vice versa.” But he believes that such a decision ought not to be made solely on the basis of a temporary adverse market movement: “Behavioural finance studies show that most people deny themselves the full increase in a fund’s value because they tend to buy when the price is high and sell when it is lower.”

He cites a paper on active portfolio management authored in 2005 by Jonathan Berk, now professor of finance at the Stanford Graduate School of Business, which notes: “Investors chase returns; a good year induces an inflow of capital, and a bad year induces an outflow of capital.”

The parallel debate is that regarding growth versus value stocks. The former are shares whose value is expected to increase at a faster rate than the market average, often because the owners of the company concerned reinvest profits rather than pay them out as dividends. It follows that the attraction of growth stocks to investors arises from the possibility of capital gains.

Value stocks are those trading at a lower price than may have been expected given the fundamentals of the company concerned and the level of shares in similar businesses. Sometimes, value stocks are the result of markets being slow to recognise improved company performance.

But the ‘growth or value’ debate is not straightforward, says Rob. The former is looking the outright winner, he says, not least because of the huge amounts of liquidity being pumped into markets by central banks, and because of the hazard of ‘value traps’ for those seeking bargains, in that there may be good reasons for a stock to appear to offer value, while doing no such thing.
"Some of the most unethical companies in the world have launched ESG funds"

“The company may have a broken business model, or too much debt,” he says. “That said, there are likely to be some hugely impressive recovery stories in the future. These can be discovered only by the best active, value-orientated investors.”

Responsible finance marches on

The responsible finance trend is unlikely to be derailed by the crisis. Research published by US financial services company Morningstar shows that European ESG fund inflows hit record levels of US$54.6bn in the second quarter of 2020. But there are worries that not all responsible finance products are what they seem, with fears that a lack of common definitions and standards around the world has opened the door to ‘greenwashing’, defined by the research and publication group Environmental Sciences Europe as “the intersection of two firm behaviours: poor environmental performance and positive communication about environmental performance”. (For more on responsible investing see The Review’s ‘Just returns’.)

Roger shares this concern. He notes that “some of the most unethical companies in the world” have launched ESG funds, but that they tend to get away with it because too many financial advisers have opted for a quiet life and put clients into such funds without the “extra level of research” needed with responsible investing. This, he says, arises from a combination of lack of effort on the advisers’ part and confusion as to what constitutes an ethical investment.

In an article published in the October 2020 edition of The Review, Neil Brown, Chartered FCSI, chair of the CISI Bond Forum Committee and chief risk officer of Earth Capital, makes a similar point, noting “the bewildering array of products and labels” in the responsible finance field. Neil says investors need to “look under the bonnet of these products” to “build a deep understanding of each one’s investment objectives and processes”.

Data analytics

Data analytics in the investment sector is an area of great potential, according to research published by professional services firm Accenture in July 2020. But too often, potential is all it is. According to Accenture, “Many asset management firms need a ‘data reinvention’ – developing the ability to analyse vast amounts of data, sometimes in real time, to fuel growth and product innovation and deliver world-class customer service.” The research reveals that “only a few” asset managers would describe their firms as “truly data-driven”, while 66% say their companies’ data management needs a complete overhaul.

Roger says the Financial Management Bureau uses data analytics in two ways. One involves a ‘dashboard’ that is reviewed weekly and includes the latest data, such as the company’s cash balances, new business activity, new leads and other top-level data. The second use of data analytics is to break data down into components for specific projects, such as the company’s series of seminars on retirement planning.

Toronto-based Quandl is a major supplier of data sets to investment banks, hedge funds and asset managers. Alongside economic and financial information, it processes and supplies what it calls “alternative data” – ranging from car sales to foreign exchange trading volumes – in order to deliver “predictive insights”. Abraham Thomas, the firm’s co-founder and chief data officer, says: “As the pandemic began to spread in 2020, we saw a sharp increase in institutional investors using alternative data to track the impact of Covid-19 on the economy and on markets.”
"People are mesmerised by change, but the eternal truths of financial planning do not change"

He adds: “Now that they’ve become accustomed to the insights that alternative data can provide, they’re acting to expand their competence – hiring data scientists, building infrastructure, and subscribing to data feeds – so they can continue to benefit from this data in a post-Covid-19 world.”

Covid-19 change

But while responsible finance and data analytics may indicate an exciting investment future, there are more sombre factors to be considered in a post-pandemic landscape. Huge public debts have been run up, interest rates slashed to near-zero, and the UK, for one, went into recession in the first two quarters of 2020, with the “biggest fall in quarterly GDP on record”, according to the ONS. It is now out of recession, but November 2020 GDP fell to 8.5% below the levels seen in February, compared with 6.1% below in October 2020.

What does this mean for financial advice? One CFP™ professional, who prefers not to be named, tells The Review: “New client priorities may well dictate a change of style. Job insecurity could reshape planning strategies, as may a permanently low interest rate environment.”

Some remain sceptical as to the likely extent of the change both within the investment sector and the wider economy. One such sceptic is Peter Sudlow. “Whenever there is a crisis,” he says, “people say, ‘this time it’s different’.” He recalls the various ructions following Black Monday in 1987 and the dot-com bubble bursting in 2000. “People are mesmerised by change, but the eternal truths of financial planning do not change. They may have to be adapted to take account of changing circumstances, but that is my job.”

To whatever extent, the investment landscape will be altered once the pandemic has passed. It is changing already. Lutfey Siddiqi, adjunct professor at the National University of Singapore, writes in a blog post for the London School of Economics: “Existing assets and entire asset classes are saturated, the outlook for returns is low, and interest rates are expected to remain low for an extended period. The wall of money released by quantitative easing needs new destinations.” These, he says, should comprise entirely “new securities and asset classes” that will bring socially responsible investing into the mainstream.

What seems to be emerging among both investors and those who manage their investments is a new approach that displays several features: a more sceptical and forensic attitude to ‘value’ stocks; an accelerated adoption of fintech; greater cost-consciousness in relation to performance, especially regarding active investment; and, perhaps above all, an historic and irreversible change in attitudes to responsible investments, shifting them from niche to mainstream. To borrow from the title of the memoirs of former Federal Reserve chair Alan Greenspan, investors will be embarking on adventures in a new world in 2021.

The full article was originally published in the February 2021 flipbook edition of The Review

The full flipbook edition is now available online for all members. 

Seen a blog, news story or discussion online that you think might interest CISI members? Email bethan.rees@wardour.co.uk.
Published: 29 Mar 2021
  • Financial Planning
  • Wealth Management
  • investment styles
  • active investment
  • passive investment
  • responsible finance
  • investing
  • greenwashing
  • ESG
  • data analytics
  • Covid-19
  • CFP

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