Why now is the time for active management

Publisher Philip Macalister spoke to Andrew Bascand from Harbour Asset Management. Harbour has over $3.3 billion in funds under management at the moment, and recently won the Morningstar Fund Manager of the Year Award for the second consecutive time.

Wednesday, July 19th 2017, 10:09AM

Andrew, you’re talking about why now is the time for active management. What’s your thesis behind that?

Well look, we’ve had five years of terrific returns - in fact, six or seven - but the last five years, very solid returns, not just in NZ equities, but globally. And we reflect on why those returns have been so solid. About half the reason, in my opinion, has been the strong rallying bonds. Bond yields have fallen, interest rates have been very low, central banks have been effectively flooding the world with a lot of liquidity, so, as a result, equity valuations have risen by about 50%.For example, take the U.S. market. The Price-Earnings Ratio five years ago was 12. Now, it’s close to 18. That’s a 50% increase.

It’s been quite benign, and the markets and the returns have come reasonably easy. That’s changing now, isn’t it?

Yeah, I think half the returns, historically, have come from Australian bond yields and that has been the easy win for investment managers. Half has come from what I call active management, with returns from investing in companies. As we look forward, we don’t want to make any predictions as to where bond yields or interest rates are going, but I don’t think we have to, because it’s hard to imagine that you get another 50% increase in valuations from here.

Financial planners are at a juncture of change now; would you argue that it’s time for them to be changing the message a little bit?

Yes, my view is it’s been quite easy just being in the market, and you’ve got what we would call technically a “beta trade”. From now on, I think there’s a strong case to revert to active management, and that’s actually looking at what you are buying, thinking about which types of style or companies are really going to provide returns in the next 5-10 years.

We’ve had so many stories out there, we’ve had Brexit, we’ve had Trump, we’ve got our own elections coming up, we’ve just had the French elections – the markets seem to be looking through all this political risk. Why do you think that is?

We just haven’t had a time with volatility as low as it’s been. In fact, people might have even forgotten what volatility used to be five or ten years ago. And when we look at that we think, “Well, we’ve had all these political noise, but that doesn’t disturb the market, so what’s actually happening?” The data has been a bit Goldilocks-like. We’ve had very low inflation, very low interest rates and growth at a moderate level, and that environment has really kept companies in a good place. Is that going to persist forever? When we think about it, probably for the next 18 months or two years, that environment may remain reasonably benign, but markets are forward-looking. And so, when we look to 2019 or 2020, the prospect of maybe a recession somewhere in the world, it begins to lift. So, the clock is ticking.

So, people just aren’t factoring the political risk in - are you comfortable with that?

I think it’s quite hard to factor in political risk because we haven’t got any policies that follow that political risk. Obviously, there are environments that would make it a lot more difficult for markets. For example, if Trump had pulled an early trigger on a trade war with China, that would have been very difficult for markets. Instead, he seems to have stepped back from that.

He’s quite good at changing his point of attack.

And hard to read. So, another example would be – what if Macron hadn’t got in in France? Of course, he did, but what if he didn’t? That could have created more uncertainty for markets.

Looking forward, how would you describe your view? Are you bullish on future returns and on where things are going?

I think we have to be concerned that markets have an elevated appreciation of the future. We don’t have to be overly fearful - I don’t think there’s any frightening aspect to where we are, but I would suggest that investors need to be considering their strategic objectives and certainly rebalancing their portfolios, consistent with those objectives, with lower return expectations than in the past. And if I could just grab on to a data point; just say the U.S. Equity Market has done 20% per annum for the last 4-5 years, approximately – half that return has been from the significant push-up in valuations. So investors should at least halve, in my opinion, their expectations of return going forward, and should anticipate more volatility.

That’s going to make the role of the financial planner - and how they talk to their clients - much more difficult isn’t it?

Well, it’s a straightforward message.

But it’s a very hard message to go and tell people.

But still, strategic objectives of clients will be met, quietly, through time, because the rebalancing they’re going to engage in will, I think, allow investors to have time to consider where they are.

But if people have thought that this is the “new normal”, and now they’ve got to wind back their expectations, it’s going to be a challenging time.

It will be, and we can see that there is a lot of optimism regarding the world economy, optimism regarding markets, and we’re probably due for a little bit of a dampening in that optimism.

Tags: bonds equities funds management Harbour Asset Management interest rates investment Markets risk yield