It's time for active management to shine

February 28, 2019 Edward Golding

           

It's been a challenging decade for active managers focused on large cap U.S. stocks. The U.S. Federal Reserve did its part to keep heavily indebted companies afloat and the entire American economy chugging along by keeping interest rates low. This resulted in an unusually long period where the stock market pushed higher and higher with little volatility.

This was great for passive investors following the overall index – but it was a lot tougher for active managers to pick standout stocks.

But the environment is changing – and rapidly. As interest rates slowly tick upwards, stock market volatility has returned to more normal levels. While market volatility can make some investors jittery, it presents opportunities for active managers to choose individual stocks that will outperform the broad market.

The best will emerge victorious

Take Walmart for example. Last week, the company posted better than expected sales and earnings and has maintained a strong outlook for the rest of 2019. Even as economic conditions become more challenging, Walmart is reporting the strongest growth in same store sales in nine years, with U.S. sales rising 4.2% year-over-year thanks to a stellar 43% jump in online sales year-over-year.

To put this in perspective, Walmart has traditionally been viewed as a brick and mortar retailer, under fire from online retailers like Amazon. The company has worked diligently to ensure it doesn't end up a casualty of technological disruption and the growth of online shopping.

Walmart has instead invested large sums of capital on building out its online distribution channels, expanding grocery pickup and delivery services, and leveraging artificial intelligence in its operation. Additionally, Walmart is carrying more apparel and home options in stores and has accelerated its expansion into high-growth emerging markets like India.

Active equity managers' ability to identify and invest in companies such as Walmart will be critical to the success of client portfolios going forward. Through skilled and thorough analysis, great active managers will find opportunities in companies with characteristics that will drive growth even during challenging times.

Picking winners

Right now, consensus earnings per share for the S&P 500 in 2019 points to moderate growth at $169 or 4% annualized growth over 2018. It's not strong, but it's not weak either.

Dig a little deeper and you'll see a couple of important factors that point to 2019 being stronger than consensus earnings. Sales for S&P 500 companies are expected to grow at 5%—more aligned with nominal GDP growth—and, at the same time, pretax profits are expected to grow at 5%, with investors anticipating higher tax rates in 2019.

This is exactly where the argument for quality active management comes in especially for 2019. The median S&P 500 stock is expected to grow earnings per share by 7% compared to 4% for the aggregate index. This 3% gap represents the opportunity for active investors in 2019.

Consider approximately 10% of companies in the S&P 500 are expected to grow earnings by 20% or more in 2019 while about 4% will see earnings decline by more than 20%. Skilled active management has the opportunity to identify the winners in an environment that is expected to be more volatile than it's been in years.

This is exactly what we do at MD, where our clients' portfolios are built using a dual approach. While the bulk of MD portfolios are allocated to active strategies, there is some passive exposure. We know there are periods of time when one style is more in favor than the other—in fact, we've seen this play out for almost a decade, especially in the U.S. market where passive investing has been difficult to match.

However, going forward, active management will be better suited for navigating market with higher volatility. Our portfolios include several active strategies from over 20 independent active managers from across the globe—all who are dedicated to generating benchmark relative outperformance while controlling for lower levels of risk.

As we move into an uncertain and volatile market environment, our active managers are poised to do what they do best.

About the Author

Edward Golding

Edward Golding, CFA, MBA, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He oversees the Canadian, Dividend and U.S. equity mutual funds and investment pools at the firm.

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