RATHBONES

AN ACTIVE APPROACH TO PASSIVES

Alex Moore, Rathbones head of collectives research, investment management, discusses how to get two opposites to work together in one portfolio

It’s not uncommon for an investment

strategy to be followed to such an extent that it becomes almost tribal. Dedicated followers of either value or growth investing are one example. Another is the active versus passive camps, where fans of index funds argue about the virtues of simple, low-cost investing which, after fees, has outperformed many active managers.

Unlike value and growth-focused investing, which should provide contrasting exposures if executed correctly, multi-asset portfolios can benefit from holding a blend of active and passive funds. The advantages of both approaches are nuanced and the choice depends on the opportunity the market presents.

Passive funds have advantages. The biggest and almost indisputable benefit is lower cost. For instance, a FTSE 100 exchange traded fund (ETF) can cost as little as five or six basis points, while some S&P 500 ETFs are even free. They provide cheap and efficient exposure to a stock market index (also called equity beta).

Through an ETF it’s also possible to gain exposure to asset classes that are difficult to buy directly, but have strong portfoliodiversifying qualities. Physically backed gold ETFs are a great example of an asset that has added a diversified source of returns to portfolios in 2020.

Far from infallible

However, when markets are particularly volatile and less liquid, ETFs can be far from infallible. Understanding these shortfalls is crucial, and can not only give active managers an edge, but also help investors make better decisions.

This situation has been more evident in 2020 with corporate bond ETFs. With more sellers than buyers during the stomachchurning falls triggered by COVID-19, and the underlying market liquidity drying up quickly, some ETFs not only fell in value, but at a quicker rate than the indices they are following (figure 1).

By taking into consideration various factors such as a bond’s liquidity (how big the pool of buyers and sellers is), duration (a bond or portfolio’s sensitivity to changes in interest rates), the underlying financial health of the issuers and portfolio cash management, active managers can have an advantage over ETFs. Lower costs are important but could prove poor value for money if an ETF is structurally flawed, or blindsided by one or more of these factors.

Under greater scrutiny

As for their equity counterparts, there are other issues to consider beyond beating an index. An income fund generally targets a

yield that is greater than the market, or can grow its dividend at a greater rate. Some active managers are trying to ensure a return with a greater degree of capital preservation in down markets.

With more scrutiny on qualitative attributes such as governance and environmental considerations, these can also be factored into an active strategy. Since the start of 2020, many UK equity funds, whether open-ended or investment trusts, large or small-cap focused, income or total-return orientated, have performed well through the extraordinary turbulence on a relative and risk-adjusted basis.

The decision to allocate to various asset classes depends on your financial objectives and goals. However, there are many advantages to building a portfolio that blends both active and passive vehicles rather than sticking with one or the other. Understanding the trade-offs between costs, asset exposure and flexibility of execution by active and passive providers can help investors reach their desired outcome. n l This is the first instalment in our series of articles

about passive and active investing — catch the second instalment in next quarter’s InvestmentInsights.

About Rathbones

Rathbone Brothers Plc, through its subsidiaries, is a leading provider of high-quality, personalised investment and wealth management services for private clients, charities and trustees. This includes discretionary investment management, unit trusts, financial planning, trust and company management and banking services.

As at 30 March 2020, the Rathbones group managed £42.6 billion of client funds, of which £6.8 billion were managed by Rathbone Unit Trust Management Limited.

rathbones.com

Mark Lacey, Head of Commodities, Schroders COVID-19 POSES TEMPORARY SETBACK TO THE ENERGY TRANSITION

The Covid-19 crisis and oil price plunge

may slow consumer appetite for the energy transition but this effect will be short-lived.

Like almost all sectors globally, the spread of Covid-19 and ensuing lockdowns have taken their toll on activity in the energy transition sector.

2020 was expected to be a record year for wind and solar power installations. That is now unlikely given the difficulties in moving the necessary component parts around the world. Some projects are still ongoing, but many others will be delayed.

The good news from the point of view of the energy transition is that such projects will simply slip into next year with activity expected to recover strongly in 2021.

Where we are cautious, and might not see such a quick recovery, is in the consumerfacing aspects of the energy transition.

Recent economic data from the US and in Europe continues to show significant job losses. Clearly, such a difficult employment backdrop will have an impact on consumer spending, especially discretionary spending.

There are two parts of the energy transition that we think will be particularly affected: electric vehicles and rooftop solar. This is different to structural spending, as buying an electric car or installing solar panels on the roof are discretionary spending decisions that are unlikely to be top priorities for households given the difficult jobs picture.

Energy transition commands policy support

However, while household budgets may be tighter, the underlying demand for action on climate change is still there. That demand comes both from the public and from policymakers. Many countries, with Europe

leading the way, are due to phase out cars with internal combustion engines in the coming years.

What’s more, the bigger targets still remain in place. While the Covid-19 crisis has understandably taken the spotlight, the climate crisis hasn’t disappeared. Countries around the world remain committed to limiting warming from pre-industrial levels to 2 degrees or less, as per the 2015 Paris Accord.

Although there has been little concrete action so far, we note calls for economic stimulus in the wake of Covid-19 to focus on energy transition measures. Europe, for example, had already proposed its Green New Deal before Covid-19 spread across the continent. Calls for recovery measures to be designed to help build a climate neutral economy are gaining momentum, with a think tank in Germany proposing a €100 billion package.

Cheaper oil has limited impact on energy transition

The falling oil price has been a feature of recent volatile markets. We would stress that oil prices have less crossover to the energy transition than one might expect.

Around 65% of all oil consumed is in transportation. Again, falling petrol prices could be another short-term factor limiting consumer appetite for electric cars, and this may particularly be the case in the US where people are accustomed to driving long distances.

However, we see it as having less impact elsewhere, especially in Europe where a significant part of the petrol price is tax and where the internal combustion engine phaseout is a much bigger part of the decisionmaking process.

It’s also notable that even the major oil companies are responding to the oil crisis by protecting their investments in the energy transition space, while cutting aggressively their conventional energy capital expenditure.

The falling oil price saw Royal Dutch Shell recently cut its dividend for the first time since the Second World War. That was to ensure that it can still make the investments it has planned in the green energy space.

Business continues to support energy transition

As well as public demand and policy support, the third pillar supporting the energy transition is the cost competitiveness of clean power. Demand for electricity has obviously fallen during the lockdowns but looks set to rebound as economies reopen. Clean energy will remain a high and growing percentage of demand as it has become cost competitive with conventional fuels.

Even in the midst of the Covid-19 crisis, businesses are still investing in renewable energy and technologies. For example the utility firm Southern California Edison is ordering a huge storage portfolio to replace gas plants and enhance the reliability of its grid.

The combination of cost-competitiveness, policy support and public demand are the three factors driving the energy transition. All three remain in place, despite the temporary impact we are likely to see in terms of household spending as a result of Covid-19.

The energy transition covers a broad range of areas, not only clean power generation and supply, or electric vehicles, but also storage, transmission and electrical equipment. The long-term structural investment opportunity remains very much intact. n l This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. www.cazenovecapital.com/uk/financialadviser/

n