Active opportunities in global markets

For investors, the global market presents a vast array of opportunities and challenges and for South African investors specifically, the recent regulatory 28 changes have opened doors to greater diversify portfolios through international markets. However, investors are contending with a new regime of greater volatility, uncertainty, and divergence in market performance resulting in a need for a more dynamic portfolio approach. If investors have confidence in their ability to pick good managers, active strategies including dynamic approaches to indexing should play a bigger role in portfolios today, in our view.

Global trends affecting investors

Investors worldwide are navigating persistent inflation, notably in developed markets like the US and Europe, which previously experienced stable returns and low inflation. The post-Covid economic reopening, compounded by rising oil prices due to the Ukraine conflict, has led to increased inflation. Central banks globally have responded by reversing low-interest rate policies and quantitative easing to combat inflation. While this has moderated inflation, it does not signal a return to pre-pandemic norms.

Inflation is expected to remain a challenge due to structural long-term ‘mega forces’ shaping our global economy, which are likely to prove inflationary over the longer-term. These include demographic divergence and ageing populations; the transition to a lower-carbon economy; and geopolitics, which has broadly seen a retrenchment from greater globalisation in favour of more inward-facing nationalistic economic policies.

Balanced against this is the rapid adoption of AI (Artificial Intelligence) across many sectors, which may offer some deflationary effects, but is unlikely to be sufficient to counter other structural changes entirely and as a result, we expect volatility and uncertainty to persist over the longer term – particularly in developed markets.

Navigating the global market in the new regime

Whilst global investment trends can impact domestic markets, direct global exposure is key to getting access to the investment themes being driven by these global mega-forces. But South African investors are yet to maximize their offshore allocation to 45% following the Pension Funds Act Regulation 28 changes allowing an increased offshore exposure. (Source: AlexForbes Large Manager Watch, April 2024)

By allocating a larger proportion to offshore investments, investors may need to re-evaluate current strategies to ensure their approach continues to add value, offer sufficient diversification, and is adapted to the current economic climate.

This era of greater macro and market volatility in the global economy may favour a more dynamic, and active, investment strategy, particularly when it comes to more granular developed equity market exposures, for example in the US and Europe.

This volatility in global stock markets in recent years has led to a greater dispersion of returns. There have been more stock-market winners, but also more losers. Investors, of course, want to try and ensure portfolios are skewed towards these winners.

In our view, these uncertain conditions are creating opportunities for skilled fund managers. We find that alpha-seeking managers acting more frequently on their insights may be better rewarded in this new regime. Does that mean skilled managers have added more active returns? Our research suggests so, even after excluding the pandemic’s most volatile periods. (BlackRock investment Institute, A bigger role for active strategies, March 2024)

 

Greater rewards for good insight

Hypothetical impact of acting on U.S. Sector Insight

Past performance is not a reliable indicator of future performance. Index returns do not account for fees. It is not possible to invest directly in an index.

Source: BlackRock Investment Institute, MSCI with data from Bloomberg, January 2024. Notes: The chart shows monthly U.S. equity returns – based on the MSCI USA – in the old and new regime under three scenarios: keeping the holdings unchanged (buy-and-hold), yearly rebalances and semi-annual rebalances. The rebalances optimize the hypothetical portfolio for returns, diversification and risk with perfect foresight of equity sector returns in the MSCI USA index. This analysis uses historical returns and has been conducted with the benefit of hindsight. Future returns may vary and these results may not be the same for other asset classes. It does not consider potential transaction costs that may detract from returns. It also does not represent an actual portfolio and is shown for illustrative purposes only.

This might seem like a step-change for investors in the global developed market. Over the past two decades active managers have found it harder to beat ‘set and forget portfolios’ – where fixed allocations to equities, bonds and other assets remained static for years. But such strategies are not necessarily delivering in this new climate.

Reconsidering active strategies

Could opting for more active investment approaches in this new regime deliver more?

Our research indicates investment expertise could prove more valuable as those with deeper market insights could exploit the resulting increase in market dispersion. This potential for greater rewards from combining a dynamic approach with investment skill is why we believe active strategies could play a bigger role in portfolios now.

Our research finds that top-quartile active returns for Developed Market equities and hedge fund managers has risen recently, suggesting that market conditions may be conducive to a more dynamic approach. (Source: BlackRock Investment Institute, February 2024) This trend is widening the performance gap between the leading active managers and their peers. This only matters if investors can reliably pick these top-ranking alpha-seeking managers that are working across different markets and asset classes.

Why? Delivering top-ranking active returns consistently is difficult. Finding managers that do requires extensive research and monitoring, which can be costly. That is more important now as the new regime more clearly separates the outperformers from the rest.

It is important to note that not all active managers will outperform when compared to passive strategies – and there are higher fees associated with more active strategies. Investors with a preference for rules-based strategies or those with a limited governance budget may choose to keep their portfolios skewed towards index solutions.

Conclusion

The new global market regime presents both challenges and opportunities. While inflation and structural changes bring volatility, they also create opportunities for active management. Investors willing to embrace dynamic strategies and select skilled active managers may find better rewards in this evolving landscape.

Read our investment perspectives a bigger role for active strategies here