Political uncertainty boosts case for active over passive funds

Passive funds have performed strongly in recent years, benefitting from relatively low volatility and more accommodative monetary policy in most developed economies, says David Macdonald, VAM Funds’sales and marketing director.

Political uncertainty boosts case for active over passive funds

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Not only has the number of index mutual funds increased substantially over the past six years, but in March even mighty Blackrock announced an overhaul of its actively managed funds.

But rumours of the demise of active management have been overstated. There is certainly still a place for the expert fund manager, with an in-depth knowledge and proven history of finding alpha, and it could be that an improved environment for these managers is on the horizon.

Near-term risks to equity markets remain and political uncertainty, from Trump to North Korea and Brexit, is bringing with it rising volatility. This could bring new opportunities for those using active strategies to highlight the worth of the expert fund manager by identifying near-term gains against the benchmark.

Headwinds for Trump

In the US, volatility looms as President Trump faces a potential struggle with his political agenda. Wall Street was broadly supportive of Trump’s package of tax cuts and the support of a Republican Majority Congress, but the President’s first test over ‘Obamacare’ has proved less than successful.

Opposition from both Republicans and Democrats has left the markets questioning whether the President will be able to make any headway, leaving his pro-growth fiscal policies in jeopardy.

Wall Street’s reaction has been an end to the so-called ‘Trump Bump’.

Adding to that volatility has been the backlash against Trump’s recent sacking of former FBI director James Comey, which has left questions hanging over the President’s head about alleged Russian hacking of the US election.

While the threat of impeachment is low, it remains a possibility and only adds to the new volatility surrounding the next years of the Trump Government.

With valuations in US indexes now looking rich, managers have an opportunity to make gains by using their expertise to take advantage of volatility and trim their allocations in favour of regions that offer better prospects.

International risk

Increasing tensions in Asia have also contributed to the potential for rising volatility that could produce opportunities for active managers over the next few years.

The region’s major economies are enjoying strengthening GDP growth, with improvement in Japan’s economy and growth in China remaining stable. However, cloudier politics resulting from recent tensions on the Korean peninsula remain a risk and the outcome is difficult to predict. The Trump administration has signalled that the ‘era of strategic patience is over’, and the possibility of further confrontation does remain a risk, stoking the potential for volatility yet further.

The future of Brexit

Following the UK’s issuing of Article 50, uncertainty also continues to surround the outcome of Britain’s Brexit negotiations. With the UK’s General Election resulting in a loss of the Conservatives majority, the prospect of a ‘Hard Brexit’ looks far less likely.

However, a hung parliament merely leaves more uncertainty hanging over Britain’s future, with the value of Sterling falling in reaction to last week’s events.

Negotiating the outcome of Brexit stands as the next task, and it remains to be seen what kind of deal can be secured for the UK, and whether it will prove a success.

Amid the current chaos surrounding the election, active managers have an opportunity take advantage of rising volatility in UK stocks which could provide them with a chance to make short term gains for their clients.

Brighter economics

Following a strong Q1, economic growth looks set to strengthen in both developed and Emerging Markets over the next quarter.

Whereas low growth and accommodative monetary policy have been a plus for passive funds, growth appears buoyant in the US, whilst both Japan and Europe have improved significantly.

In the Emerging Markets, Russia and Brazil continue on the road to recovery from recession and even the UK has enjoyed unexpected growth.

Inflation in the US, whilst down from its February high of 2.74%, sits above 2%. 

The Fed has already started to tighten monetary policy, and the potential for further rate hikes do lie ahead.

Elsewhere, in the UK inflation continues to rise, hitting 2.7% in April, and across the G20 inflation stands on average at 2.4%.

Low GDP growth in the past may have constrained company profits, but with economic momentum firming, active managers are waiting for a tightening of monetary policy and rising inflation that brings with it the opportunity to benefit from stronger earnings growth.