The sharp spike in volatility seen in 2022 resulted in passive funds suffering their first year of outflows on record in the UK. They also underperformed active funds for the second straight year. The likelihood that volatility will remain high in 2023, given the fragile state of the global economy, should provide opportunities for active managers across a range of asset classes.
Continuing high levels of volatility augur well for active managers
It’s true in the asset management industry that active managers tend to perform best during periods of high volatility, when sharp moves in asset prices unearth opportunities to buy cheaply and sell at a premium. Active managers can also adjust investors’ portfolios to make sure they’re best placed for the prevailing market conditions, either increasing exposure to take advantage of a short-term opportunity or hedging positions to protect the portfolio.
Inflation surged as economies emerged from Covid-19 lockdowns, placing immense pressure on global supply chains as demand rocketed. Russia’s invasion of Ukraine in February 2022 fuelled concern about the global economic outlook, with inflation rising further on the back of soaring commodity prices.
These events sparked considerable uncertainty about how high interest rates would go, as central banks abandoned the loose monetary policies in place since the global financial crisis. This, in turn, generated sharp moves in equity, currency and bond markets. Global passive equity funds suffered the worst outflows, but these were negative across all major geographies except emerging markets, according to Calastone. The sector also fared worse than active funds for the second straight year. 1
The US consulting and marketing firm Agecroft Partners believes that long/short equity managers – especially those that focus on small and mid-capitalisation stocks – should benefit if, as expected, markets remain volatile in 2023. It argues:
‘Small-cap stocks are currently trading at extreme discounts compared to their large-cap peers and are also a less efficiently priced segment of the market due to limited sell-side analyst coverage.’ 2
Volatility is also creating opportunities in fixed income, where markets are offering the highest yields, spreads and total return potential in years. Extreme economic and geopolitical uncertainty, accelerating inflation and aggressive global central-bank policy tightening drove the sell-off in all areas of the market in 2022.
Many asset managers believe the trends seen in 2022 will continue. JP Morgan Research, for example, in its 2023 outlook (published in January), forecast that market volatility would remain elevated, with the Volatility Index (VIX) averaging around 25. 3
VIX index spikes in 2022, with forecasts of renewed upturn in 2023
Pictet points out that in almost all recessions since 1929, markets have hit bottom during the recession itself, rarely in the year before, with volatility similarly tending to peak during recessions. In its December 2022 outlook, the Swiss asset manager said it expected the VIX to average 25 over 2023, with a potential peak of 40.
Global economy remains fragile and risks abound
The outlook has improved in early 2023, with the International Monetary Fund (IMF), for example, upgrading its forecasts for the global economy in its World Economic Outlook, published at the end of January 2023. It explained that global growth had proven ‘surprisingly resilient’ and most countries would avoid a recession during the year. The IMF said its improved outlook reflected the reopening of the Chinese economy and falling energy prices in Europe.
However, considerable risks remain. It admitted that the US economy would grow by only around 1%, that the path for avoiding a recession in the world’s largest economy was ‘narrow’ and that higher interest rates were ‘certainly going to cool off the economy and bring down inflation’. The organisation warned that interest rates could rise more than markets expect and take longer to come down, particularly in the US.
Moreover, tensions between China and Taiwan remain high, while the IMF remains concerned about the severe financial pressures facing the Chinese property market. It’s not hard to find reasons to suggest volatility will remain high in 2023, creating a myriad of opportunities for active managers.
1 https://www.calastone.com/passive-funds-see-their-worst-month-of-outflows-on-record/
2 https://www.marketsmedia.com/top-hedge-fund-industry-trends-for-2023/
3 https://www.jpmorgan.com/insights/research/market-outlook#:~:text=Market%20volatility%20is%20also%20set,Fed%20overtightens%20into%20weaker%20fundamentals.
4 https://www.ft.com/content/043e6c32-0da4-45ba-8c5c-89f53198d7f1
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