Investment - hands off, hand on

Investment - hands off, hand on

The business of investing, and the ownership of the corporate sector, have seen a lot of change in the last 40 years. Private investors have shifted savings from actively managed equity funds, which seek to outperform the market, to lower-cost passive funds that track markets. Institutions and wealthier investors have gone in the opposite direction, towards greater involvement by buying stakes – and control – of companies and other assets.

• Stock market dates back to 1602 with trading of shares in the Dutch East India Company in Amsterdam. It was not until 1924, more than 300 years later, with the launch of the Massachusetts Investors Trust, that investors could access so-called pooled equity funds. These allowed investors to own a diversified portfolio of shares, transferring the burden of stock picking and day-to-day portfolio management to expert investment managers.

• So-called active management grew rapidly and, by the latter part of the last century, had eclipsed direct holdings of equities for retail investors. 

• The role of the active fund manager is to allocate their clients’ money to those companies they think are most attractive, hopefully avoiding duds and not paying over the odds. It’s a difficult business and it is very rare for a fund to achieve sustained outperformance against the market. An analysis by S&P Global found that well over 90% of actively managed US, European and UK equity funds have underperformed their broad markets over the past ten years.

• The costs of active fund management and the difficulty of beating the market led to the emergence of low-cost funds that aim to mimic the performance of the entire market by tracking an index. Vanguard launched the first index-tracking fund in 1975 and today it is the second-largest asset manager in the world. Vanguard’s approach was summed up memorably by its founder Jack Bogle as, “Don’t look for the needle in the haystack. Just buy the haystack!”. The world’s largest asset manager, Blackrock, also manages the majority of its assets on a passive basis.

• Part of the appeal of passive funds is cost. A passive fund may have charges as low as around 0.2% a year while active funds can charge in excess of a percentage point more.

• Yet equity markets play a crucial role in making markets efficient. By researching companies, evaluating their performance, and making informed investment decisions, active investors help ensure that stock prices reflect the latest news and information. If the entire market consisted of passive investors, there would be no price discovery, meaning that share prices would fail to react to developments affecting the underlying companies.

• Passive managers have to buy stocks that are increasing in value and sell those that are declining in value to match the benchmark weighting. This can result in investors being heavily exposed to a narrow range of expensive stocks, as has been the case with the rise of the so-called ‘magnificent seven’ US tech stocks, which have come to dominate the entire US equity market.

• While private investors have shifted towards passive investment, institutions, such as sovereign wealth funds and pension funds, have become more active by increasing their exposure to private equity (PE). PE firms use investors’ funds to acquire control of public or private companies, improve performance before selling the company and returning money to investors, often after 3 to 5 years. PE firms have tended to make heavy use of debt. In 2022 leverage ratios averaged 5.9 in US private equity deals, according to data from PitchBook.

• The performance of PE businesses has been much debated. A study published last year by The Productivity Institute at the University of Manchester examined all PE acquisitions in the UK between 2000 and 2021 and found that acquired firms saw a lasting improvement in productivity compared to other firms with similar characteristics and, crucially, that this endured even after the PE fund sold the business. They also found that PE-owned firms tended to see stronger growth in employment and capital expenditure.

• The management fees charged by PE firms tend to be well in excess of those charged by an active or passive equity fund – an annual management fee of 2% and a 20% share of profits is not unheard of. Yet a 2024 review of more than 90 academic studies of PE performance by Swedish economist Alexander Ljungqvist found that even after fees returns have historically outperformed public markets.

• A harder question is whether the returns sufficiently compensate for the additional risk and loss of liquidity. PE-owned companies typically hold more debt than public companies, increasing the risk of business failure in a downturn while, unlike in public markets, funds are tied up for many years. It is also worth noting that PE’s performance has lagged behind public markets in recent years, in part due to the stellar performance of the US tech sector.

• The investment landscape has been transformed, with retail investors increasingly favouring passive index funds for their simplicity and affordability, while institutional investors turn to PE for potentially higher returns, despite the associated risks and illiquidity. This divergence highlights the shifting dynamics of financial markets – and varying levels of appetite for risk and excess return among investors.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 0.2% at 8,647. 

Economics

• The German Bundestag approved the incoming chancellor Friedrich Merz’s proposals to increase the public deficit beyond its current limit to allow for greater defence and infrastructure spending
• The OECD cut its global growth forecasts, with chief economist Álvaro Pereira saying that “trade uncertainty and economic policy uncertainty are having a significant toll”
• The US Federal Reserve maintained interest rates at 4.25%–4.5% and said that further declines in inflation were “probably delayed for the time being” amid recent uncertainty
• The Fed also reduced projections for US growth this year, from 2.1% to 1.7%, and lifted their inflation forecast, from 2.5% to 2.8%, citing US president Donald Trump’s imposition of import tariffs
• Investors reduced their allocations of US equities by a record amount in March, according to a survey of fund managers by the Bank of America,
• The Bank of England maintained interest rates at 4.5%, as expected, as it continues its “gradual and careful approach” to reducing rates. Markets expect the Bank to reduce interest rates to 4% by the end of 2025
• The pound rose above $1.30 for the first time since November last year
• Annual UK wage growth remained steady at 5.9% in the three months to January
• The UK government announced plans to reduce welfare spending by approximately £5bn a year and civil service spending by £2bn a year by 2023
• UK chancellor Rachel Reeves suggested taxes on big tech firms may be changed as part of a deal to avoid US president Donald Trump's next raft of tariffs
• UK consumer confidence unexpectedly improved in March, but remains in a “fragile” state, according to GfK who compile the index
• German economic sentiment improved considerably in March, according to ZEW, probably reflecting greater optimism in the light of the government’s plans to ease fiscal policy

Business

• Shares in Chinese EV manufacturer BYD soared to a record high following its announcement of new charging technology that can add over 400 km of range in 5 minutes
• US tech company Oracle announced plans to invest $5bn in the UK over the next five years, focused on cloud services infrastructure
• Gong Cha, the brand behind the popular drink Bubble tea, announced a major UK expansion of 225 shops and nearly 2,000 jobs
• The Association of the British Pharmaceutical Industry labelled the UK as “uninvestable” following the recent rise of the medicine sales tax
• European technology companies, including aerospace manufacturer Airbus, have called on the EU to create a sovereign infrastructure fund and “buy European” to boost investment in new technologies and improve strategic autonomy 
• Sports broadcasters, including ITV and BBC, have been fined over £4m by the UK’s Competition and Markets Authority regarding collusion over pay of freelance workers

Global and political developments

• Israel renewed ground operations in Gaza and launched a series of air strikes as the ceasefire with Hamas collapsed
• Large European NATO members, including the UK and Germany, are discussing plans to reduce Europe’s dependence on the US over the next five to ten years, the FT reports
• Volodymyr Zelenskyy rebuffed a proposal by Donald Trump for the US to take over Ukraine’s nuclear power plants to ensure greater protection against Russia. The US also hoped to reopen discussions on accessing Ukraine’s raw minerals, the FT reports
• Canadian prime minister and Liberal Party leader Mark Carney called a snap national election, scheduled for 28 April
• Protests ensued following the arrest of Istanbul’s mayor Ekrem İmamoğlu, the main political rival to Turkey’s president Recep Tayyip Erdoğan, over terrorism and corruption charges
• Atmospheric carbon dioxide levels reached an 800,000-year high in 2024, according to the UN’s World Meteorological Organisation, with last year likely to have been the hottest on record
• London’s Heathrow Airport was shut down last Friday amid a power outage that caused significant travel disruption

And finally… the Dutch city of Utrecht launched its ‘fish doorbell’ system on its river lock. The video link allows millions of online viewers to alert authorities when fish are held up by the lock on their migration journey - live-streaming