Sunday, March 1, 2020

The Coronavirus epidemic is striking fear in the markets - I'll gladly take an active manager over an ETF

You can sing the praises all day long of your passive ETF investments, but in the midst of the Coronavirus epidemic I’ll gladly pay a little more in fees for an actively managed fund

Go ahead – naively hold investments in the shares of restaurants, amusement parks, hotel and cruise companies in your ETF – I’ll let my active fund managers decide which firms and sectors are going to be hit the hardest in the long-run as the result of the Coronavirus outbreak.

Additionally, I’ll let my active manager identify the areas where opportunities exist – while your naïve passively managed strategy takes it on the chin. The central banks aren’t going to be able to stimulate demand with zero or negative interest rates forever – and they are running out of further stimulus tricks in their bag.

The Coronavirus epidemic could cause serious short- and long-term consequences to consumption-linked stocks and they can have a knock-on effect on other sectors and geographic regions. So, go ahead and talk about your lower fee ETFs and I’ll see you next year and we can compare our risk-adjusted performance! I will take active investment management over an ETF - especially now.

The debate overactive versus passive investing has been well documented. Depending upon the time period and the asset classes selected, it remains an open question. Additionally, risk-adjusted performance needs to be taken into consideration as to which of the two strategy is best. I also contend that when the markets cease to be supported by global central banks who intervene every time the market drops by 10%, then we’ll begin to see the value of active management come forth.

Given the black swan event of the past two months involving the Coronavirus epidemic, I will pay more in fees to have an active manager navigating the turbulent markets. When massive outflows begin to occur in less-than-liquid ETFs, I’ll be glad I have active fund managers protecting my downside risks.

As stocks fell across the board - and recorded their worst weekly performance since the 2008 Financial Crisis during the last week of February, numerous investment opportunities have begun to appear. And while the Coronavirus is serious and its potential to spread globally remains uncertain, it should be noted that active managers can sell the stocks most negatively impacted and buy those that have been oversold. This isn’t the case with an ETF – you hold all the stocks in the index regardless of whether or not they are going to be decimated by Coronavirus fears. 

Currently there is significant market dislocation occurring which will present excellent opportunities for active managers to showcase their skills.

Okay, by way of full disclosure – I am the director of Marquette University’s Applied Investment Management (AIM) program where I teach active management. Therefore, I firmly believe in the ongoing value of active investment management and its ability to help investors achieve their long-term objectives.

To that end, the AIM program is preparing the next generation of investment managers – we given our students the autonomy to manage a portion of the University’s endowment. 

The students hone their valuation skills and develop investment processes that allow them to identify and act upon opportunities. Through their detailed analysis and research, they learn how to manage funds in a responsible, ethical manner. We apply rigorous risk controls and avoid significant deviations from our benchmarks; however, we believe in active management and its ability to generate value.

The AIM students employ a process to identify innovative, well-managed companies and then they overweight the stocks they believe to be future outperformers. We do this weekly so that we can react to shifting investment themes by altering industry and individual stocks weightings. And when markets are challenging – like they are presently with Coronavirus, the student-managers can avoid areas with deteriorating outlooks, helping to protect the University’s capital.

We see value in passive investing for smaller investors and for times when an inexpensive and quick means of gaining exposure to a sector or investment theme is needed; however, at the end of the day we prefer sound, grounded active investment management.