The Case For Active Management

The world has been on a bull market tear since the financial crisis of 2008. We are still seeing record highs in various indices throughout 2017. The indiscriminate buying in passively managed funds has been a serious contributor to this phenomenon and it will likely be the reason the next market crash is more severe in terms of loss and recovery time.

Passive investments rely on the efficient markets of modern portfolio theory in order to work. Basically, it means that buying and selling of stocks is based on fair market pricings and there is a greater return for investing in investments that have a greater risk. But this reasoning is fundamentally flawed because markets are far from efficient. Here is just one example by way of proof.

On June 16, 2017 Amazon announced they were acquiring Whole Foods. Let’s take a look at how some of the major US grocery stocks performed. You can see the closing prices on June 15 (the day before the announcement) and the intra-day low for each stock on June 16th after the announcement. Kroger traded down as much as 16.7%, Target down 12.4% and Walmart down 7.1%.

Overall, roughly $30B in market cap was wiped away from grocery, retail and food companies considered likely to be directly impacted by the announcement.

Markets reacted immediately. But then sober second-thoughts start to creep in. Analysts do some digging and find out that Whole Foods has annual revenue of $16B. Compare that to Kroger who does between $130-135B in grocery revenue and Walmart who does $220B in revenue. Rational thinking says “Amazon – even with this acquisition – is a long way from dominating grocery. And by August 2nd, all three stocks had rebounded to prices above the pre-announcement levels.

Even the most transformative events can take months if not years to play out. If they ever come to pass at all. In the meantime, the tendency of the market to overreact in the immediate aftermath of news - before they have fully assessed the situation and analyzed the information and data, shows the inefficiency upon which active managers can seize and take advantage.

Source:  Empire Life

For more information why you don’t want to invest passively read Are you swimming naked? & Is This Your Doctor?

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