The end of loose monetary policy caught many managers out last year due to a rapid rotation away from growth stocks. Companies that had dominated the post-financial crisis era tumbled, while the former laggards rose to the top of the rankings.
This year is likely to be one of uncertainty. Rates continue to rise, but the pace of central bank hikes has slowed as inflation has fallen from its peak.
I have heard a range of likely outcomes, from central banks continuing to raise rates throughout the year, to stopping in the summer, and even to cutting again before 2024. All options seem credible and (if argued well) even likely.
A period of uncertainty is when active fund managers should thrive. By picking stocks that come out on top in specific market conditions, they can bet on winners and outmanoeuvre the market.
Most managers believe they can achieve this through bottom-up stockpicking – or, in other words, by focusing on company fundamentals. For quality managers, this might involve looking for companies with strong balance sheets, healthy profit margins and steady growth. For value stockpickers, a cheap share price with the potential to rebound is the main focus. Finally, growth managers look for the prospect of making extraordinary gains at some indistinct point in the future.
However, speaking to an exchange-traded fund (ETF) expert this week, it became apparent that none of these strategies may come out on top. He made the argument that as long as markets are myopically focused on central banks, energy prices and other macroeconomic factors, fundamentals will continue to struggle for relevancy.
After all, the best company in the worst-performing sector may still underperform some of the worst performers in a surging sector.
For example, energy stocks are currently in vogue, with the likes of Shell and BP making bumper profits. This has little to do with the underlying fundamentals of the businesses and more to do with rocketing commodity prices.
Growth companies in areas such as tech have tanked, not because they are poor businesses, but because interest rates are now discounting a higher risk-free rate – why pay for potential growth in the future when you can get a 4.25% coupon from a 10-year UK gilt today?
Much is made of the value that fund managers can add by stockpicking and there are certainly some that have proven their worth in a multitude of different market environments.
However, many tie their colours to a specific style, leaving the decision on whether they will outperform or not down to the individual investor.
It means that now more than ever, investors that want to make money in the short term will require a thorough understanding of macroeconomic factors. This comes with risk, but can be lucrative if they are proved correct.
Those that cannot afford or are unwilling to make these calls and wish to invest for the long term, however, may have to take some lumps in the short term if they invest in funds that are not geared into the current economic conditions. Diversification can help and, although this will result in lower overall returns in the long run, should be a priority for every investor.