Emma Wall: Hello, and welcome to the Morningstar series, 'Ask the Expert.' I'm Emma Wall and here with me today is Morningstar's Portfolio Manager, Cyrique Bourbon.
Hello, Cyrique.
Cyrique Bourbon: Hello, Emma.
Wall: So we're here today to talk about the fact that active managers haven't done too well in the last three months. They've managed to underperform the market, haven't they? Particularly, those that invest in developed markets.
Bourbon: That's a very good point. We've seen – looking at the second quarter in particular, notable rollover of performance of active managers after admittedly very good 2013 and also to a certain extent 2012.
Wall: So what is it that they've got so wrong?
Bourbon: I think active managers in general tend to have a bias towards small and mid-caps first, and then obviously as I was saying in the last couple of years, they've had a bias towards more cyclical sectors; industrials, consumer cyclicals, consumer defensive in some cases, where they were attractive. But generally typically more of a cyclical bias.
Wall: So is this evidence that the end is nigh? That this fantastic rally in particular, UK and US and indeed some European stocks have had since the credit crisis, this is all over? Is that true?
Bourbon: My personal view is that this is not all over. I think valuations were getting a bit stretched in a lot of the parts of the markets and the change of internal dynamics we've seen in market since the kind of middle of March is probably more of a resetting of expectations than anything else.
So you've seen – and did some notable sell-offs in kind of growthier part of the market, for instance in the U.S. and in the U.K. as well, like biotechnology, technology stocks as well, especially in the mid- and small-cap more growthy areas, losing 20%, 30%, 40% and even more in some cases. So it's been more I think a resetting of expectations rather than a fundamental shift of markets.
Wall: I was speaking to Philip Matthews, manager of Schroder UK Alpha Plus earlier and he has had a 60% portfolio turnover, since taking over the fund last year and he said exactly this is because the stocks that have done well over the last three, four, five years aren't the stocks that have continued to do well. So, which managers then are best-placed and which strategies are best-placed to act this out?
Bourbon: I think there is a – if we take a step back one of the key message we're getting from most fund managers we're seeing these days and that's valued across most markets, UK, Europe, US as well on the developed side, the key feedback they are telling us is that fundamentally there hasn't been a change in terms of the expectations for companies. So, in terms of underlying businesses, in terms of potential for earning upgrades they are still there. So, that's typically a good indicator for us in terms of what could happen to earnings going forward and potentially share price performance.
So, in my view, I think we've had a bit of reset in our expectations. Fin probably had gone up too much one way, so needed to be normalized a little bit to become more realistic levels. And hopefully, as investors start to digest the news flow that comes through in the upcoming earnings season and as global economic growth hopefully picks up and carries on especially in the UK for a local market, which has been pretty good in the last few months, we should see that come forward in terms of numbers at the company level.
Wall: So, perhaps then it's a case of not being so short-termist about that second quarter in 2014, just because the active managers have underperformed in the market for those three months, they may not do so going forward.
Bourbon: Hopefully. Obviously, there are some different styles as well. So, you mentioned a fund manager who's been rotating his portfolio quite a bit. There are other managers which tend to be much more long-term, see very bottom-up and those typically haven't turned their portfolio around very much.
However, some other managers who will tend to be a bit more pragmatic and take into account the macro environment a bit more would be much more active in terms of portfolio positioning and those might indeed have changed their portfolio quite substantially actually in the last three to six months.
Wall: Although many elements of the U.K. stock market have rallied significantly, there is value to be found, there is value to be found, isn't there, in other sectors, and particularly rather surprisingly the mega-caps.
Bourbon: Exactly. The mega-caps has been the standout performer in the last three, four months. The theme we've been talking about for some time has been M&A, and obviously M&A in the large-cap can happen and we saw this with AstraZeneca (AZN) a couple of months ago with some speculation that Pfizer (PFE) would bid for it, and we're seeing a lot of M&A this year in general across the entire market, especially obviously mid and small caps.
But again, there was a catalyst for large caps to do well and M&A could be the one. Also valuations in some part of the mega-cap can be attractive at times and healthcare had been a sector that was attractive for couple of years and obviously has been a good performer this year.
Wall: Where then should investors be looking to exploit this difference in valuations and indeed to make sure that they are taking into consideration what the FTSE would do going forward?
Bourbon: I think the best way in my view is to leave it to good fund managers. I think we are still in an environment where stock-picking is critical and there's definitely the case for giving your money to a good stock-picker. Typically, most stock-pickers take into account the macro in they're thinking, into their bottom-up analysis. So you would expect them to do the job for you in many ways. So I would go for some stock-pickers who should avoid the blow-ups and who should back up the winners for the long-term.
Wall: Who's been doing this effectively?
Bourbon: We've had couple of managers doing it well, and indeed those have typically done better this year. A good example is Threadneedle UK, which is managed by Simon Brazier, and he's done very well by tilting the portfolio in a very balanced manner between cyclicals and defensives, but not overtrading.
He's been very much at the margin and his stock-picking has been very strong. So he's had some good exposure towards the more economic sensitive areas of the market, but also some good exposure to some defensive sectors.
Obviously, in the last three or four months, where defensive sectors like utilities, like healthcare, like tobacco companies in the U.K. have done well, he's been well exposed to those. So he's actually had a good balance of exposure there and some good returns.
Wall: Cyrique, thank you very much.
Bourbon: My pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
