Preferring active over passive in the current environment?

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SIMON BROWN: I’m chatting now with Luigi Marinus. He is head of discretionary fund management at PPS Investments. Luigi, appreciate the early morning time.

In a recent piece you put out you talk around our being in a golden age of passive investing. A couple of years ago passive overtook active mutual funds in the US. The data shows active struggling to beat the index. But you also point out that this really has been helped by that golden age – low rates, practically no inflation, tons of liquidity in the market.

That’s not always the case. As things shift we might need to rethink some of our thinking around passive versus active.

LUIGI MARINUS: Good morning Simon. Yes, that is 100% correct. We can’t ignore that passive has done particularly well over the last while. And it’s been coupled with, of course, passive being relatively cheap compared to active managers as well.

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I think the point that we want to make is just that things can change. So having a combination of passive and active is generally the way we would advocate for funds to be set up for solutions in the DFM [discretionary fund manager] case. So just be careful, because the expensive stocks are becoming more expensive, and at times eventually that does turn around.

So the idea is maybe not just to be fully in passive, [but] have some diversified exposure across different asset classes as well.

SIMON BROWN: I get you. I like that and I want to come back to what you just said there a moment ago, which is it’s ‘a blend of’ – and we’ll park that for now.

But in the immediate the challenge with passive is that concentration. It has gone up. We know about the tech AI concentration. We forget about the local concentration – 10 stocks half of the index.

And then of course valuations. We love those valuations on the way up; we made money from it. But now that gets risky. This is now the risk to that passive, because nothing goes up forever.

LUIGI MARINUS: Exactly, exactly. And the thing that drives passive the most is momentum of course. And momentum is almost defined by the most expensive and the largest stocks getting more expensive.

That works well under certain market conditions, like you just mentioned now, and it has been the case over the last few years as well.

What I want to say is more a different way of thinking about it in a way. If you think of, say, value investing versus growth investing – and people have been thinking about that for a long time – we know that value does well for a while, and eventually it turns around and grows as well for a while. It eventually turns around.

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So that’s how we would think about it from an active and passive perspective. The difference, though, with valuing growth is generally that active management costs are very similar, and now people are saying, well, the cheap part of the market is doing well, so why do we even have to worry about the other side of the market?

But at the end of the day, at some point it’s likely that we’re going to see that turnaround, and that kind of normal cyclical way that markets do work. Our point is more to just be mindful of that and be careful. That that may happen at some point.

SIMON BROWN: Absolutely. Gotcha. You make the point – it’s a core beta exposure. Absolutely. And that’s what it does.

But at times – and this is perhaps one of those times – we need to sort of shift that exposure. I like your value versus growth analogy there. That active versus passive. It’s not saying, let’s move completely out, but let’s shift some of that focus to the active because this is a different market from what we’ve seen over the last decade.

LUIGI MARINUS: Yes, we do think so. And the question globally around AI is: Is it a bubble or not? That’s really difficult to predict. But what is likely is that there are going to be some winners and there are going to be some losers as well.

And if you have an active manager that can maybe get some insight into what they believe to be the winners, and which ones they believe to be the losers, they might end up with a better outcome than a passive investment that’s going to be invested across the board, regardless of whether they think it’s going to do too well or not.

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So there is that value, I think, in the active managers that can use some discretion, especially when things are quite expensive and you’re forced to buy those expensive counters. Kind of taking away a little bit from that could be quite helpful going forward.

SIMON BROWN: Absolutely. And I’m thinking – we’ve touched on this, but it bears repeating – that in many senses passive chases the hot new thing. And SpaceX is a recent example.

As an active investor, you might look at that valuation of SpaceX and think, whoa, don’t know if I want it. As a passive investor you were buying it regardless.

LUIGI MARINUS: Exactly, and that’s by definition, and it has worked well for a number of years now, both locally and globally; probably even more so globally.

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But we have seen, like you said, a lot of the hot counters getting even hotter, and that coupled with a lower fee as well. So you understand why investors are excited about it and saying this part of the market is definitely the way to go.

But I think just some kind of rational thinking around it – and seeing what the risks are for that – is an important consideration.

SIMON BROWN: Yes. And the hotter parts of the market are just getting hotter. I like that. That is the concern. That is the worry.

We’ll leave it there. Luigi Marinus, head of discretionary fund management at PPS Investments, appreciate the early morning.

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