It has been said that those who do not learn from history are doomed to repeat it. With the value of active management called into question in recent years, we are compelled to consider our history to see what we might be able to glean about the realities of today’s environment.
Active managers have come under fire during the market recovery that started in 2009. Many failed to keep up with their benchmarks as markets rallied. If history is any indication, however, this underperformance may have reached a bottom. A recent chart that appeared in the Wall Street Journal shows active management could be ripe for an upturn.
We’ve Been Here Before – Each Trough Has Been Followed by Recovery1
As the numbers demonstrate, today’s underperformance relative to the benchmark may not be so unique after all. Let’s take a deeper look at some of the periods on this chart and how Manning & Napier fared during these times.
Greed in 1987
Throughout 1987, Manning & Napier steadily decreased equity exposure in client portfolios as stock markets climbed higher. Although we were criticized for missing the continued bull market, we stuck to our belief that stocks were overvalued based on their underlying fundamentals. Our Long-Term Growth strategy trailed its benchmark in seven of the twelve quarters preceding the fourth quarter of 1987; however, in October of that year, the stock market crashed and the S&P 500 fell 22.5%. Our commitment to fundamental value, which sacrificed returns during the latter stages of the bull market, positioned our clients to weather the downturn. Long-Term Growth went on to achieve strong absolute and relative returns over the next several years.
Fear in 1990
From a war with Iraq to an oil price spike, markets experienced a series of shocks in 1990. The stock market dropped more than 13% in the third quarter of that year, and the U.S. economy subsequently fell into a recession. Our Long-Term Growth strategy lagged its benchmark over several time periods by the end of September. Despite the turmoil, however, we maintained equity exposure based on our long-term outlook. This discipline paid off as Long-Term Growth produced strong absolute returns that outpaced the benchmark throughout the early ‘90s.
Irrational Exuberance in the Late 1990s
By mid-1995, Manning & Napier began to grow concerned about the greed in the market. Instead of pursuing the hot tech companies of the time, we sought opportunities in foreign equities and mid-cap stocks. Then, in August 1998, the U.S. stock market fell by more than 14% as the Asian financial crisis unfolded. Our reluctance to hold U.S. large cap stocks, coupled with exposure to foreign equities, led to our Long-Term Growth strategy experiencing almost double the decline of its benchmark in the third quarter of 1998. Once again, we stuck to our portfolio positioning, and our returns well exceeded benchmarks over the next one, three, and five years following September 1998. Remaining focused on fundamental value ensured our clients’ assets were well positioned during the severe price correction that ensued.
Each of these case studies provides an example of the value of active management in specific scenarios, but what if we look at a longer (and more recent) time period? After all, performance results are most meaningful over full market cycles – i.e., through a bear market, subsequent recovery, and eventual bull market. The chart below illustrates the value the Long-Term Growth strategy has provided vs. its benchmark over the current U.S. stock market cycle, which represents both good and bad markets.
Despite the variety of market environments we face, remaining selective and active is a central tenet of our investment philosophy. Today, we are seeing a significant number of sentiment-driven trades in the market, with the Fed reportedly set to continue raising interest rates. History has shown that sentiment-driven markets cannot continue indefinitely, and periods with rising rates generally lead to lower correlation and a larger spread between the best and worst performing stocks, all of which can favor active management. In this type of climate, active strategies tend to outperform, as shown in the chart below.
Outperformance of Active Funds vs. Interest Rates2
If active managers can take advantage of the current environment and remain focused, they could be on the brink of yet another upturn.
Active managers like Manning & Napier try to help investors reach their goals while managing risk along the way. We look at fundamentals, valuations, and the competitive strengths and weaknesses of potential investments. Indices, meanwhile, are based on quantitative metrics like market capitalization in stocks, or bond issuance volumes in fixed income. Our differentiated methodology explains why there are times when active management dramatically outperforms, or why there are times, as in recent years, that we appear out of favor. We’ve been here before, and we’ll be here again. When we take into account both history and the current environment, we believe being an active manager today is critical for long-term success.