For stock pickers, it's the dream that will never die: An aging bull market prone to violent dislocations will revive their fortunes as they buy overlooked winners and snub losers.
Things haven't gone according to plan over the years as the passive revolution marched on. But the underbelly of the equity markets is flashing more bullish signals for the besieged industry.
More shares are marching to their own beat and relative valuations are looking stretched, giving investors across Europe and the U.S. fresh opportunities to beat the index. Even the red-hot ETF market is seeing rare outflows of late as more money managers flock to single stocks.
And as late-cycle volatility flares up, bidding up benchmarks looks perilous versus more dynamic strategies that hedge risk-on, risk-off markets, the theory goes.
It all helps to explain why in a watershed year when U.S. passive funds are projected to manage half of all assets, the likes of Fidelity International, Goldman Sachs Asset Management and Berenberg are in fighting spirits.
"The market environment is really changing," said Mark Phelps, chief investment officer of global concentrated equities at AllianceBernstein in London. "Quantitative easing meant buying beta and the best way to access it was via ETFs, no question. But now we're looking at alpha, and now is the time to find active funds."
There's evidence investors are migrating out of passive vehicles to wager on single equities as macro risk reduces the allure of undifferentiated allocations via the benchmark. U.S. and European ETFs were stung by $16 billion of redemptions in January even as developed markets added trillions in value, according to data compiled by Bloomberg.
On the flip side: Investors on Bank of America Corp.'s platform this year have bought about $4.8 billion in shares of individual companies, excluding buybacks, while selling some $5.3 billion of ETFs across the board.
"Clients continued to buy single stocks and sell ETFs, which has been the case for the last four consecutive weeks," the firm's strategists Jill Carey Hall and Savita Subramanian wrote in a Feb. 5 note.
Sure, rebalancing for tax reasons may have something to do with it, and as the maxim goes, flows follow performance — explaining some of the withdrawals from large-cap ETFs last month after the December meltdown. Deutsche Bank, for one, expects this trend to reverse thanks to encouraging U.S. data. And the rotation is just a drop in the ocean compared to the decade-long preference for ETFs over single stocks.
Nonetheless, facing a dovish Federal Reserve and headwinds to corporate earnings, Wall Street banks including Bank of America and Morgan Stanley are touting active bets as a ticket to outperformance.
The logic is simple: As stocks sway to their own tune, money managers have ample opportunity to boost exposures to securities that exceed the index return while underweighting the laggards.
Equity valuations in the U.S. coming into the year were more spread out than any time since the crisis era, according to Bank of America. Meanwhile, the degree to which European and American stocks swing together has tumbled after they moved almost in lockstep in October. Within Europe, traders expect the link between individual shares will fall to the lowest since at least 2011.
"We'd expect active managers to be able to outperform in this kind of environment as correlations fall relative to a period of suppression of volatility through monetary stimulus," said Shoqat Bunglawala, head of the global portfolio solutions for EMEA and APAC at Goldman Sachs Asset Management.
In Europe, in particular, the valuation rift between the cheapest and priciest stocks has been widening to multi-year highs, a boon for relative-value hedge funds.
Another rationale for stock-picking right now: The market is particularly unforgiving this earnings season. According to Morgan Stanley, U.S. companies that miss profit expectations are underperforming peers with positive surprises by the most since 2017.
Idiosyncratic forces are in play, too. U.K. investors had better wager on individual equities as opposed to factors like quality as Brexit risks vex traditional revenue projections, according to Sanford C Bernstein.
Still, the call to active investing has rung hollow over the years — and the expectation of outperformance in a weak market arguably runs counter to the historic norm. After all, there's no divine reason why rotations spurred by shifting risk appetite or correlations should hurt passive investors in particular — emerging-market ETFs and defensive developed strategies, for example, have seen bumper inflows of late.
Another big caveat: If price swings rise, it can ramp up correlations and hit stock pickers along the way.
"It remains to be seen whether more volatile markets will be a boon for active managers and the historical evidence is fairly mixed in that regard," said Citigroup analyst Louis Odette.