Strategic Investment Research Group

Active Managers Poised to Outperform?

Defensive, income oriented sectors of the equity market such as Utilities, Consumer Staples, Telecommunications, and REITs have outperformed the S&P 500 Index over the past 12 months.  This has created a performance headwind for active managers who, for the most part, tend to be persistently underweight these sectors.

 

This paper will discuss the drivers of the recent performance of the so-called "bond proxy" trade, provide an updated perspective on active managers' views, and outline some of the risks that investors may be overlooking.  Out conclusion is that  there is considerable downside risk associated with the bond proxy trade should interest rates rise, and that active managers are poised to outperform in such an environment.

 

Falling Rates a Headwind for Active Strategies

Investment managers have identified defensive, higher-dividend-yielding, “bond proxy” stocks as potentially crowded positions. Being underweight these types of stocks, which investment managers often described as expensive and vulnerable to underperformance in a rising rate environment, has been one factor contributing to underperformance year to date.

Most active managers have been on the wrong side of this trade so far in 2016. It remains to be seen whether or not they will ultimately be proven right. It is early days yet, but most U.S. equity managers that we have been talking to don’t anticipate making any major changes to their portfolios as a result of “Brexit,” as most U.S. companies have relatively little exposure to UK sales.

Accordingly, large cap equity managers may continue to face headwinds in an environment characterized by falling rates, “risk-off” sentiment, or “dovish” surprises by the Fed. Conversely, rising rates, “risk-on” sentiment, and hawkish Fed surprises would tend to be tailwinds.

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