The New Millennium has started with a reminder of how fickle markets can be. Investors’ love affair with technology ended fairly abruptly in late spring and has been followed by a trail of disappointment, including failed promises, loss of confidence and collapse. ‘So, what’s new?’ I hear you say, ‘Love affairs often end in tears’. But it’s not just technology. As I write this, the Dow is off 9.5 per cent, the FTSE100 is off 10 per cent and Japan is off 24 per cent, with Ireland one of the few markets to show positive local currency returns. Famous brand name companies, such as Procter & Gamble, down 31 per cent, have seen their share prices decimated this year as well. Probably we are witnessing the return to normality after a bout of investors’ mass hysteria, such as was described by Charles Mackay in his 1852 classic Extraordinary Popular Delusions and the Madness of Crowds.
Two developments stand out within of the investment management market in the past year. These are the growth of private investors and the growth of indexation. Private individuals have become a very important part of daily activity in equity markets. In some stocks they provide the major part of liquidity, and their views can determine the direction of markets. For example, the boom in technology shares was driven by momentum investment, spurred on by internet chat-room rumours and day trader activity. The subsequent bust has been like a cold shower, making previously confident individuals looking for an alternative to the roller-coaster ride. Eircom investors, who chose the giant slalom instead, are looking for an alternative as well. Investment managers offer that alternative. The virtues of using of investment managers are that risks are spread by investing in a range of assets, and that information overload is avoided by delegating the daily monitoring of markets to the professionals.
The second big development is the continuing growth of passive indexation. If the previous development is like love unfulfilled, then this development is like love disappointed. The big movers of funds to an indexation approach are those pension funds which have been disappointed by active investment managers who have missed their short or medium term benchmarks, a trend started in the US, where over 30 per cent of funds are now managed on a passive basis. The irony is that many passive funds are more active than their actively managed counterparts, due to wholesale changes in index constituents that are ongoing, thereby incurring additional transaction charges. These portfolios also have technical dealing rules, which can lead to distortions of the market, a recent example being the price spike at entry of Dimension Data into the FTSE100 last September, partly caused by demand from index funds for the stock. Leaving these difficulties aside, index portfolios do ensure that investors can monitor the movement of their funds without the fear that their fund manager is not following the market.
How does an active manager do business against this background? The key ingredient that active fund managers provide is confidence built off a solid track record and a clear investment process. Investment managers in Ireland have a very good record of investment returns, and are competing in Ireland and overseas against the best in the world. The increasing wealth, both of private individuals, and pension funds has attracted ever more competition into Ireland and in the New Year this will increase, with the availability of gross roll-up funds and tax-assisted savings schemes for individuals and the new State Pension Reserve Funds. We are ambitious and want to win every time. No one said it would be easy, but we are confident!
Product design will become more important. In theory, this should be easy. James O’Shaughnessy, in his recent best selling investment book What works on Wall Street, outlines many strategies for active management that outperform the S&P500 index return for the US by a very long way. He writes that, in the period 1955 to 1996, the market return was 11.5 per cent pa but he also outlines forty three strategies that were better, returning up to 18.6 per cent pa. In practice, while active managers have plenty of choice of strategy, they have been driven to close adherence to benchmarks by the short-term issues of comparative performance against other managers with very similar product offerings. This will change and active managers will prosper only if they can offer choice.
Among the main alternatives to direct equity investment for private investors and to the traditional managed pension fund will be dedicated international equity funds, perhaps value or growth, hedge funds, venture capital funds and guaranteed funds. Some of these are already available here, and more are on their way. These all have an equity bias and may leave room for other products such as corporate bond and property funds to fill the gap for income funds. All of them will have competitive fee structures and increasingly will include a performance incentive so that clients will know that the fund manager shares the pain as well as the gain.
Looking forward, the Irish continue to compete for business in open competition with the best in the world, both here and abroad. Expect innovative new products and diversity of choice, clarity of investment process, and more, all coming from your local investment manager.
Martin Nolan is Director of Strategy and Process at Hibernian Investment Managers and is chairman of the Irish Association of Investment Managers. |
