Willis Towers Watson urges shift from passive to active management
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Willis Towers Watson is advising its clients to shift from passive to active asset management, amid growing concern about the risks of passive equity investing.
The investment consultant, one of the most influential gatekeepers in the pension fund industry, advises on roughly $2.6tn in assets.
The move comes as a UBS report suggests that the meteoric rise of passive investing is slowing down.
Luba Nikulina, global head of manager research at Willis Towers Watson, said the firm had been raising concerns about the risks of concentration in passive equity for about three years.
The consultant is “now discussing it” with all clients that have the capacity and governance resources to choose active management over passive, said Nikulina.
Negative climate change implications for passive investing and more favourable conditions for active investing are also arguments for the shift, she said.
“I do believe that it is significant as it signals the reversal of the long-term trend towards passive,” said Nikulina. “In terms of new flows, we are definitely recommending this shift.”
Nikulina said that in the US market, where there have been the largest inflows, passive investing was “very concentrated” in the small number of companies investors are exposed to.
The largest six companies in the S&P 500, including Apple, Microsoft, Amazon, Facebook, Google and Tesla, account for almost a quarter of the index and the bulk of returns, she said.
“It’s been a good run but the more it grows, the more it lowers the probability it will continue, and there is risk in the concentration of the largest names.”
Nikulina added that technology companies made up about 40 per cent of the index and questioned whether investors were getting the diversification they really wanted.
She added that passive investment meant investors missed out on companies that are increasingly choosing to stay private rather than go public, and where, in the knowledge sector, there was “more growth and more success”.
She said passive indices were also quite exposed to old economy businesses, which had issues with carbon intensity.
Increasing market volatility since the Covid-19 outbreak, along with forecasts of “more pronounced” volatility once government stimulus is removed, creates new opportunities for active management, she said.
Nikulina added that the trend affected passive equity more than passive fixed income, as the latter still has an important role to play for pensions’ liability matching purposes.
The forecast that flows will shift from passive equity to active equity comes as recent research from UBS shows that passives failed to gain market share among European equity funds for the first time in a decade last year.
The Swiss bank expects passive penetration to slow in 2021 and beyond. According to UBS, Europe’s active equity managers also enjoyed the highest alpha generation in two decades last year.
“While we don’t expect passive penetration to stop in the coming years, the strong alpha generation in 2020, the rising popularity of ESG funds and elevated volatility levels should act to slow passive penetration in the coming years,” UBS said.
Paul Doyle, director at Bfinance, an investment consultant, agreed that conditions looked more favourable for active investing than they had for some time.
The longer-term dynamics of investment moving to Asia and other emerging markets, as well as environmental, social and governance concerns, and carbon credentials in particular, play to the strengths of active management and alpha generation, he said.
In an index there is a lot of mining and oil stock, which “may not play into what you want as an ESG-conscious investor”, said Doyle.
The more recent dynamic of the pandemic and government stimulus will result in lots of winners and losers, he added. “When markets turn bearish, there is no real hiding in passive mandates.”
Jo Holden, UK chief investment officer at Mercer, said there were certain headwinds that suggested there could be a reversal in flows from passive to active but that this would be a “huge move”.
“The stance we take is passive has its place,” said Holden, but added: “We firmly believe in high-conviction active management, and the investment themes playing out over the next couple of years lead us to think there could be quite a high dispersion of returns across countries.”
She added that the pandemic was expected to lead to a lot of defaults and said that scenario would lead to opportunities for active managers.
However, some are less convinced about any slowing down in the relentless march of passives.
Amin Rajan, chief executive of Create Research, said the industry has been waiting for a reversal in flows from passive to active since 2005 and it had not happened.
“Passives have their weaknesses but these are more than offset by the powerful tailwinds they enjoy while central banks continue to influence asset prices. This is unlikely to change in 2021,” he said.
“Passives will continue their upward march, while actives will attract fresh assets to take advantage of volatility. It is impossible to predict how their relative shares will change: both will have a place in investor portfolios.”
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