Marian Poirier

After decades of stimulus, consumption and cheap debt, investors are being urged to reassess the nature and purpose of passive and active investing and how they support portfolios in a dramatically changing world, according to three global investment managers.

Addressing the challenges involved in building long-term-focused portfolios, three global investment firms, Baillie Gifford, MFS Investment Management and Orbis Investments are jointly hosting a series of events for institutional and wholesale investment communities next week in Melbourne and Sydney.

Featuring presentations from leading portfolio managers and investment officers from each of the firms, with a keynote address from finance professor Hendrik Bessembinder, renowned for his research into stockpicking, the program will focus on what matters most for the creation of long-term capital at a time of once-in-a-generation economic change and global reform.

Reversing trends

Against a global backdrop of structural change for markets, the three investment managers say many of the market tailwinds and trends that have long prevailed have run their course or are reversing — offshoring to onshoring, globalisation to nationalism, minimal capex spending to mandated capex, technology driving revenue not cutting costs. These are seismic shifts that are giving life to new trends, opportunities and ideas and where active investing has the advantage through early discovery.

‘Active management comes in to its own when you consider big shifts in society over the next decade or more and how innovation is supporting long-term change, whether that’s the transition to clean energy, the future of transport or food, or breakthroughs in biology that could cure cancers and disease’, Rosemary Shannon, Client Director at Baillie Gifford, said.

‘Academic research and other sources of intelligence can tell us a lot about what’s changing in the world and where to look for successful companies. It is these opportunities that investors vulnerable to short- term sentiment and market noise can miss out on.’

Fertile ground for stockpickers

The trio believe the current environment of change is creating headwinds for even the best of companies, and while some won’t survive, there will be those that emerge or transform to offer differentiated value, retain pricing power and grow market share. Each regard that the next market cycle will be a reckoning where fundamentals will reveal a growing spread between responsible winners and unsustainable losers.

‘While every boom–bust cycle follows a similar pattern, they are also different from each other’, Jason Ciccolallo, Managing Director at Orbis Australia, said.

‘An environment of loose money stimulates the economy and fuels rising asset prices, sometimes to the point where it’s unhealthy and dislocations occur. As the cycle matures, these ever-rising asset prices can distort behaviour, leading to undisciplined capital allocation decisions. This has seen some eye wateringly high company valuations in certain sectors that are now reversing, although the valuation dispersion between the expensive and cheap stocks is about as wide as we have seen it.

‘Investing’, Ciccolallo continued, ‘in a more complex landscape will demand an increased focus on fundamentals and the price of an earnings stream. Increased discipline will be particularly critical in a world where central bank stimulus has dried up. Every environment produces opportunities, and the one we’re in today is ripe with possibilities — it’s fertile ground for stockpickers.’

Moving to a three-dimensional investment model

The trio say the evolution of investing from a two-dimensional risk and return model to a more complex responsibility-centred model is placing a greater onus on investors, including those in passive strategies, to become more actively engaged.

‘Just as active managers place tremendous pressure on issuers to demonstrate sustainable business models, so should investors, active and passive, apply scrutiny to what they own’, Marian Poirier, Senior Managing Director at MFS Investment Management, said

‘As an industry that funds 80% of the world’s public markets, we have the responsibility to ensure that not all companies receive financing all the time. Active investing is about a bigger, longer game that aligns portfolios with where long-term, financial and societal value is. The days of easy finance are behind us, and active management can ensure client funds are allocated to companies whose balance sheet affords them the luxury of investing in their business for the long term as responsible winners.’

Exposure versus responsible ownership

The collective believe that passive strategies certainly have had a place in portfolios for their low-cost beta exposure, but they also that their limitations, in a world embarking on changes unprecedented in scale and number, need to be better understood.

‘While passive capital allocation has supported portfolios during past growth-dominated decades, its hands off nature and limited ability to engage and hold companies to account have inadvertently contributed to mounting risks in markets that are now reversing through active engagement’, Poirier said.

‘An index is not a fiduciary; indices can’t think and don’t care’, she added.

‘Alpha’ and ‘ESG’ losing meaning in an era of complexity

The trio highlight the dangers of ‘alpha’ and ‘beta’ exposure descriptions having evolved into convenient ways of holding the industry to account and in so doing embedding agency risk and short-termism in markets.

‘As an industry we need to do a better job of defining what alpha is, in a holistic sense’, Poirier said.

‘If an investment chosen for its long-term earnings resilience outperforms a benchmark representing the winners of the day, can we really call that alpha? Likewise, if that long-term investment underperforms a benchmark comprising companies that have optimised profits today at the expense of future earnings, should that indicate failed alpha? The question becomes alpha against what?’

The trio see similar flaws in the way products are labelled.

‘Company and fund-led actions designed to appease current investor enthusiasm by ‘greening’ investments and operations may actually be at complete odds with ESG objectives, which may be more aligned with transforming assets for a low-carbon economy’, Poirier said.

‘While ESG objectives won’t become any less important, we think a better term could be ‘stakeholder capital’ because building a more sustainable future for companies and investors needs long-term partners and allies. We believe metrics need to better engage stakeholders such as investee company boards, executives, policy leaders, think tanks, academics, market regulators, legislators and not least clients to support genuine ESG objectives. Each has a stake in the process of change, and, importantly, all have a stake in achieving desired change and the prosperity that comes with it.’

‘Growth at any cost’ is dead

The trio argue that the highest-return-at-any-cost approach to investing is not in the best interest of investors, nor has it ever been, given its destructive effect on markets, societies and environments.

‘Long-term investing is about generating strong returns for our clients, but our choices also affect society and the environment. We take that responsibility seriously — because it’s the right thing to do and it makes us better investors’, Shannon said.

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