Eric Marais
Passive and growth strategies have enjoyed remarkable success for many years, but investors have grown too complacent and are not positioned for a changing investment world, according to Orbis Investments.
The contrarian global equity manager with A$59b assets under management has released its “Five considerations for 2025”, informed by analysis of long-term data, which highlights the areas it believes investors should be carefully considering when planning for the year ahead and decade beyond.
Eric Marais, Investment Specialist at Orbis, said, “Throughout 2024, we have seen developments in global markets that amplify concentration, style, and return risks. Many investors continue to structure their portfolios around last year’s winners, but we believe investors should now consider what needs adjusting – most likely their portfolios and their expectations.”
The five considerations are:
1. Periods of great returns historically give way to periods of poor returns
Investors should be reminded that “periods of great returns historically give way to periods of poor returns – and those returns are poorest when starting valuations are expensive,” said Marais. Placing this into context, in the 10 years leading up to 2021 passive world index investors enjoyed 11% real returns (returns after inflation), yet in the 10-years to 2008 investors lost 2% after inflation.
Given that the last decade delivered phenomenal stock market returns, investors should expect the next decade to be much more challenging.
2. Returns on passive global equity investments could be as low as zero for the next decade
“While valuations are a poor predictor of short-term returns, they matter a great deal in the long run,” said Marais.
Orbis has reviewed historical valuations dating back to the 1970s, and across a dozen different metrics; the data shows that extreme valuations have been followed by poor subsequent returns. “Our research suggests that passive investors in global equities could expect a return as low as zero, after inflation, in the next decade if historical relationships hold,” Marais said.
3. Indexing is a momentum strategy by stealth
History has shown that when bubbles burst, the most expensive assets fare badly. At these junctures, the world’s most valuable companies lose their leadership positions, and future leaders are likely to be quite different in the decade ahead. This is a unique problem for passive funds that hold shares in proportion to their market capitalisation. “That feature makes indexing a stealth momentum strategy – a huge benefit to passive investors through the persistent trending market of the last decade but a danger when the trend reverses,” said Marais.
4. Concentration risk is extreme
“Static investment strategies do not lead to static exposure but increased concentrations in winning stocks,” Marais said. Today, market indices—and thus passive investors—are heavily skewed towards unusually expensive US growth stocks. The MSCI All Country World Index—the most diversified major global index—has 17 per cent invested in just the ‘Magnificent Seven’ companies, 25 per cent in technology sectors, and 64 per cent in a single country and currency (US). Each of these three areas is more richly valued than its opposite. “The US market trades at 27 times earnings versus 16 times for shares elsewhere, while tech shares are valued at a whopping 39 times earnings”, said Marais.
5. Active strategies don’t guarantee diversification
Orbis notes that concentration issues are not confined to indices and passive strategies. Money tends to flow to the best-performing active-managed funds, which often share style characteristics with what has been driving the market. Today, the biggest active retail global equity funds in Australia are highly correlated to growth styles. Across the top 10 largest actively managed global equity funds, not a single fund has a Value style according to Morningstar’s Equity Style Box methodology. 66% of active assets are in Growth strategies and the remaining 34% is in Core. “Investors may hold active funds for diversification but depending on the underlying investments, they may be diversified in name only and are at risk when the dominant style falls from favour,” said Marais.
“Investors need to diversify across styles within equities. Markets in aggregate are expensive but not uniformly expensive and plenty of value remains available globally for active stock pickers. Holding undervalued assets can make a remarkable difference to investors’ returns in downcycles.”