Many equity investors are grappling with how to invest in today’s market, when volatility has increased yet valuations are still high. For answers, we asked Portfolio Managers Lucy Macdonald and Karen Hiatt – two of our most experienced stock-pickers – to share their thoughts on active investing in turbulent times.
With correlations among global equities relatively low today, there is more scope for divergent performance among different names; this plays directly into stock-pickers’ strengths
High-tech disruptions across sectors are opening up opportunities for active investors to discern among different equity names
Rising rates could help stock-pickers: As valuations are adjusted to reflect growth outlooks, cash flows and balance sheets more accurately, performance variation should increase
With more participation from passive and quantitative investors, the markets could see bigger swings and more pronounced dislocations; this helps enable active investors to select opportunities one by one
How do you feel about the current market environment – particularly given your focus on active stock selection?
Lucy: The environment for active global equity investing has been fantastic during the past year, and we believe it’s likely to continue. Correlations are relatively low today, meaning stocks aren’t moving in lockstep as much as they were in the not-too-recent past. As a result, there is more scope for divergent performance among different names, which plays directly into our ability to look for the right stocks in a range of areas. Moreover, technological improvements are causing huge disruptions across sectors, opening up additional opportunities for stock-pickers like us.
Karen: The growing dispersion evident in today’s market is a positive factor for us. The rising interest-rate environment appears likely to increase how much performance varies among equities, as valuations are adjusted to reflect more accurately the differences in companies’ growth outlooks, cash flows and balance sheets. This allows active managers like us to select companies that may be better-positioned to outperform in this environment.
Stock Correlations Have Been Lower Overall, Creating Divergence and Opportunity
S&P 500 Index stock correlations (January 1991 to February 2018)
Source: FactSet as at 28 February 2018.
Historically, when the largest stocks in an index lead the market, the environment has grown more difficult for stock pickers. Are the FANGs making things harder for you?
Karen: The major responsibility of a stock-picker is to aim to forecast future earnings when they aren’t anticipated by the broader market. So despite some fears of a market driven by the likes of Facebook, Amazon, Netflix and Google – the “FANG effect” – big is not necessarily bad. The market has a tendency to lean on the largest companies with the greatest transparency, but if these companies have the competitive advantages to drive outsized earnings growth, then it is our responsibility to capitalize on them by positioning our portfolios accordingly.
How does the recent increase in volatility impact a stock picker’s ability to outperform?
Lucy: Periods of normal volatility create more opportunities for stock selection, whereas high-volatility periods are generally accompanied by high correlations – and that isn’t the best time for stock pickers. When volatility is high, it’s a good time to buy into long-term names. Fortunately, the spike in volatility that we saw in February has subsided significantly. Still, it’s a good reminder that when the level of noise in the market clouds how performance is coming through, it gets harder to determine if underlying fundamentals are driving a stock. Over time, however, the alpha generators should become clear.
Karen: We’re seeing more players in the passive and quantitative space participating in the markets. That invites greater potential for big swings and pronounced dislocations. In times like these, we focus on trading around core positions while looking to take advantage of what happens in quant-driven volatility spikes – we look to pick off opportunities one by one as they present themselves.
Has the growth bias in the marketplace affected the ability for stock pickers to outperform – and if there’s a tilt to value, how would that change things?
Lucy: There can be sharp low-quality rallies in any market, but they don’t tend to last long. If you stay true to your philosophy, you will likely come through. Karen and I have been doing this long enough to know how to take advantage of buying opportunities.
Karen: In my view, secular trumps cyclical. Certain underlying building blocks favour growth investing – factors like acceleration of technological advancements and long-term competitive advantages – which is why we believe if we pick secular stocks, they should outperform over time. Cyclical outperformance, on the other hand, requires a perfect cyclical environment that can be fleeting over time.
Some or all the securities identified and described may represent securities purchased in client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. The securities or companies identified do not represent all of the securities purchased, sold, or recommended for advisory clients. Actual holdings will vary for each client. FANG is an acronym widely used on Wall Street and among many investors; it stands for four high-performing large-cap technology companies – Facebook, Amazon, Netflix and Google (now Alphabet) – that are also household names.
Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan];and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.
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