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Uneven growth, rate rises could revive active managers' fortunes

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Uneven growth, rate rises could revive active managers' fortunes

Amid rising interest rates and uneven global growth, active fund management is enjoying a resurgence in its long struggle against passive, index-based funds, according to new data. Some observers speculate this might presage a longer-term trend.

In the first six months of 2017, nearly 80% of sterling-denominated actively managed funds in the U.K. outperformed their benchmark, according to the mid-2017 results of the biannual S&P Indices Versus Active Funds Europe Scorecard. The rebound in actively managed investments from June 2016 to June 2017 contrasts sharply with the 10-year period to end-June 2017, when almost 72% of active managers in all U.K. categories underperformed their benchmarks.

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Active management has made gains elsewhere, too: In the U.S., the percentage of active funds exceeding their benchmarks rose to between 52% in the year to June 2017, from 10% the year before. But it has made its greatest gains in the U.K. which, with £6.9 trillion in AUM, is Europe's largest asset management center, and second in the world only to the U.S., according to a September 2017 report by the Investment Association.

Passive management has had a better run, overall, during the past six years. This trend has benefited firms like BlackRock Capital Investment Corp. and State Street Corp. which primarily offer exchange-traded funds and index funds that track a particular market and charge lower fees. The average is 0.6% of AUM.

In turn, consolidation has increased among firms that focus on more active portfolio management, looking to companies' fundamentals to spot trends and market mispricing. They charge higher fees — on average 1.4% of AUM. Big tie-ups that illustrate this trend include the merger of U.K. firm Henderson and U.S.-based Janus asset management in May 2017 into Janus Henderson Group Plc, and that of management firm Aberdeen with insurer Standard Life, forming Standard Life Aberdeen Plc in August.

Active management 'comeback'

Historically, active management's comebacks have been multiyear rather than shorter, said David Gilreath, a partner at Sheaff Brock Investment Advisors. Active management, for example, fared better than passive from 2001 to 2011, and for six years in the mid-1990s, he said.

Part of the reason for active managers' poor performance since the 2008 financial crisis has been high market synchronicity, a condition in which stocks largely track macroeconomic trends and each other, said Andrew Folsom, senior investment analyst at the Wells Fargo Investment Institute.

Share prices largely moved in unison from the 2008 financial crisis to the start of 2016, with movements dictated by economic data or central bank moves. Observers point to the "risk-on, risk-off" behavior of nervous investors who quickly sell portfolios when news events drive markets down. Paying pricier active managers to chose between stocks that moved mainly in lockstep is less attractive for many private and institutional investors, when passive products offer similar returns more cheaply.

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But the likelihood of interest rate increases destroys this synchronicity. "We are moving away from the easy monetary policy which we believe held correlations up across markets," Folsom said.

The extent to which share prices move together in unison has declined to 18% in 2017 from 60% in 2016, and is at one of its lowest levels since 2004, Andrew Sheets, chief cross asset strategist at Morgan Stanley, said in an Aug. 21 note. Financial stocks rose more than other stocks because of expected interest rate increases and U.S. deregulation; energy and materials stocks climbed because of a recovery in commodity prices.

"Return dispersions [between different stocks] are getting bigger, creating ideal conditions for active managers," said Amin Rajan, CEO of London investment research firm CREATE-Research.

Small-cap funds

U.K. active managers specializing in small-cap funds performed especially well, generating 38.3% returns compared with 22% by the S&P SmallCap Index. Aberdeen's U.K. smaller companies equity fund A, for example, led its benchmark by 7.0% between January and August 2017, after trailing it each of the preceding five years. By contrast, large-cap funds track overall markets more closely, and give active managers less of an edge over their passive peers.

"So those fund managers with less exposure to larger names would have found it easier to outperform," said Andrew Innes, associate director for research of S&P Dow Jones Indices.

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Some active management firms have also seen inflows and profits revive in 2017. Schroders Plc's net income rose by 17% in the half ending June 30 over the year-ago period, while Legal & General Group Plc's investment management division reported a 13% increase in operating profit in the six months to June 30.

Actively managed AUM is on track to reach $74 trillion worldwide by 2020, a 26.7% increase from $58.4 trillion in 2015, PwC predicted in June. By comparison, passively managed funds are set to grow from $11.3 trillion in 2015 to $23.2 trillion by 2020.

The two forms of management increasingly will coexist and "need to learn to live alongside one another ... with each having an edge over different points in the cycle," said Campbell Fleming, global head of distribution at Aberdeen Standard Investments.

S&P Dow Jones Indices and S&P Global Market Intelligence are owned by S&P Global Inc.

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