When markets are under stress, focusing on companies that have more consistent earnings growth and profitability can help position a portfolio for long-term growth when volatility subsides.
Why You Should Use Active Equity Funds Now
5 min read
Key Takeaways
- Actively managed investing aims to create portfolios with return potential that exceeds the broader market. At AllianceBernstein, our active equity funds are focused on companies and businesses.
- Research, combined with quantitative analysis, underpins high conviction in our holdings. It’s applied in different ways across a range of strategies that cater to diverse investor needs and risk appetites. Yet all our active equity funds use a disciplined process for choosing stocks, managing risk and constructing portfolios.
- In a world of macroeconomic uncertainty and market volatility, we believe an active approach focused on company fundamentals is essential to find stocks that can perform well over time—and to avoid those that are more vulnerable to deteriorating conditions.
What is actively managed investing in equities?
Actively managed investing is when a professional investment manager applies research, skill and a defined philosophy to choose stocks that will outperform a benchmark—typically a common equity market index. The ability to select stocks that can generate alpha—or returns in excess of the market—can be extremely valuable in an environment of low expected returns. Not all active managers outperform, of course, and the conditions that generally favor active management don’t always prevail.
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Active investing is a very different approach from passive equity investing, which seeks to track the movements of a published equity market index in order to provide investors with low-cost access to broad equity markets. Passive investing also has its place in many clients’ portfolios, but it’s not without risk, either. For one thing, many passive strategies tend to follow the herd into certain market segments and stocks, which may create crowding risk. Crowding can also create flight risk if conditions deteriorate, since passive strategies must sell broad numbers of stocks in order to reduce exposure. This mass migration might also create liquidity challenges, with so many investors moving for the exits simultaneously.
In our view, active investing is most effective when applied with high conviction—applying exhaustive research to identify companies that seem best suited to the strategy’s philosophy and objectives. This helps avoid a common pitfall of actively managed equity investing—managers that end up with portfolios that aren’t much different from the benchmark. The key to effective active management is the ability to identify high-conviction stock choices that deserve a greater weight in an investment portfolio—and can drive stronger returns over time.
How can actively managed investing help investors in volatile markets?
Global equity markets have been extremely volatile in 2022. But actively managed equity funds that use a fundamental approach to companies can help investors chart a course through the uncertainty.
For example, in 2022, volatility has prompted a sharp contraction in equity valuations, particularly among growth stocks and technology companies. This creates opportunities for active managers to identify attractive entry points in companies with relatively solid profitability and earnings prospects.
Active equity managers can also focus on lower-volatility stocks with resilient businesses to create a portfolio that is more capable of withstanding market shocks. This type of portfolio aims to lose less than the market during a downturn, which makes it easier to recoup losses in a future recovery.
Geopolitical risk is another big driver of market volatility. But it’s almost impossible to predict outcomes of these events, from wars to election results, and they often have surprising effects on markets. Active investors can avoid stocks that are especially vulnerable to geopolitical outcomes, and focus on those with more predictable earnings patterns, even in times of limited visibility.
What are quality companies from the perspective of active equity investing?
High-quality stocks can be found in diverse sectors and industries, and range from companies that are more sensitive to economic cycles to those that enjoy profitable growth drivers.
We believe actively managed funds that prioritize quality in their everyday stock-picking processes are better equipped to identify durable companies that have what it takes to get through uncertain times and thrive in a recovery.
Dominant businesses, competitive advantages, innovation and management skill are among the features of high-quality businesses that can deliver dependable cash flows over time. Investors can assess quality through three lenses: persistent earnings and profit growth, strong free cash flow, and healthy balance sheets.
The three characteristics above are interconnected. Companies that generate consistent free cash flow are in a better position to cover their debt-servicing costs—even when there’s less cash to keep the business afloat. And low earnings volatility is a good indicator of a company’s ability to perform through complex and changing business conditions. Companies with all three of these features have much more flexibility to navigate short-term market stresses and longer-term challenges.
Actively managed equity funds measure quality in stocks in different ways. Yet the characteristics of resilient companies have something in common—they tend to underpin consistent, long-term equity return potential. Over the last decade, the MSCI World Quality Index returned 12.4% annualized, outperforming the MSCI World Index. And during past market crises, quality stocks usually fell less than the broader market, a pattern that we’ve observed over longer time periods and in both US and global markets.
How can active equity funds be used during high inflation?
Rising inflation can add challenges for equity investors. Extremely high inflationary environments have subdued equity performance in the past; however, in periods of moderate inflation, stocks have generally done well.
As inflation rises, actively managed equity funds can look for companies with pricing power—a key differentiator in an inflationary world. For example, in consumer-oriented companies, we study brand power in different markets and ask whether premium products will be vulnerable in a tougher economy. Even if companies can raise prices, we seek to determine whether this will be enough to cover cost inflation and/or lead to a reduction in demand.
Some inflationary pressures are driven by supply issues. Active investors can study a company’s supply chain to determine whether it is adapting to these challenges by creating alternate sources of supply to alleviate cost pressures.
Rising prices can squeeze profit margins. In actively managed funds, we study cost inputs—from raw materials to labor—to determine whether a business is well positioned to maintain margins in an inflationary environment.
By applying fundamental knowledge, research and expertise to these areas, active investors can build portfolios with companies that are more likely to withstand inflationary pressures and maintain earnings and cashflow growth that support long-term return potential.