With the rise of exchange-traded funds, cheap commissions and a persistent Fed quantitative-easing policy that seems to perennially push stocks up in unison, active managers can’t get no respect.
But this won’t last forever. Trends play out in cycles in the markets, and sooner or later active managers will show their worth again.
So it makes sense to buy their beaten-down shares now, ahead of that shift. That’s what insiders at several active management companies are doing. Value investors I follow closely also have a keen interest in these names. This makes sense because they look cheap, the produce tons of cash flow, and they aren’t going away — despite the Rodney Dangerfield rap they get these days.
Here’s what might make active management come back into style.
• QE finally fades. Sooner or later the Fed will launch a plan to taper quantitative easing that doesn’t frighten investors into throwing a temper tantrum. So the taper plan will persist. At that point the entire market dynamic will change because stocks won’t go up in unison anymore. Stock picking will matter again.
“It’s hard to beat the S&P 500 SPX, +0.30% when everything is going straight up,” says George Putnam, an active manager who pens The Turnaround Letter, which recently featured eight investment companies as buys because they are so cheap and unloved. “But I don’t think that is going to continue for the next five years.”
“Indexing has been fantastic during the QE era because you didn’t have to be smart, you just had to be in,” says Kelley Wright, who pens a value-oriented stock letter called Investment Quality Trends. As QE eventually fades we’ll “enter a new trend where you actually have to be smart and know how to pick stocks,” he says.
• Volatility comes back and stays around a bit longer. We got a taste of how nasty the market can be to investors last winter. Many self-guided investors tend to be too emotional, too ill-informed, and too inexperienced to know how (or whether) to ride it out. Professional money managers are better at this.
“Advisors prove their worth by having a disciplined and unemotional approach that allows investors to participate in the gains even if they don’t beat the S&P 500,” says John Buckingham, an active manager who edits The Prudent Speculator stock letter.
A phase of continued volatility would shake out the self-guided investors and send them back to active managers for safety — and hand holding if their accounts are big enough.
• A recession arrives. This will create a bear market and sustained losses that will have self-guided investors throwing in the towel and putting their money into managed funds. “The next time we have major correction and investors get killed in their index ETFs, they are going to say ‘I have to do something different,’” says Wright. Leaving the driving to professional money managers might be the trick.
When will all the above catalysts actually happen? That’s hard to say. But we are definitely closer to the end of this economic cycle than the beginning. In the meantime, a lot of active managers have something else going for them. Many operate in niches where they are more likely to add value by beating benchmarks.
“In terms of large-cap U.S. stocks, ETFs may be hard to beat over the long run,” says Putnam. “It is a pretty efficient market. But when you get into niche areas like U.S. small caps, international stocks or fixed income, these areas are complex enough that it is easier to beat the market over time.”
Morningstar data bear this out. The February edition of its Active/Passive Barometer report card on active managers found that they tend to beat their benchmarks most often in international, small-cap and fixed-income investing. Large-cap growth is the toughest area for active managers to win, says the report. “As people realize ETFs are not the right vehicle for all sectors, that will benefit active managers,” says Putnam.
All of this probably helps explain why there’s interest in the group among insiders (who are buying) and value investors I like to track. So I think it makes sense to put money into these stocks. These companies pay nice dividend yields, backed by prodigious cash flow. So you get “paid to wait.” Valuations suggest significant further downside may be limited, barring a bear market. No guarantees, of course.
Here are six favored by Putnam, Wright, insiders, and my own stock letter, Brush Up on Stocks.
Oaktree Capital Group
Yield 6.9%
This shop OAK, -0.54% has “great expertise” in investing in distressed debt, says Putnam, who is also active in that space. Buying the distressed debt of companies struggling with bankruptcy will come back into favor sooner or later, because of the huge amount of corporate debt floated in recent years — much of it lower quality.
“There is $1.7 trillion of lower-quality debt that comes due over the next five years,” says Putnam. “If there are any hiccups in the market, it will be hard for some of these companies to refinance. That is a lot of raw material for a firm like Oaktree.”
Franklin Resources
Yield 3.3%
Known for its venerable Templeton funds, this investment shop BEN, +1.00% has been struggling because of its focus on international and value investing, two areas with mixed performance of late. “But they are a very well-run company that generates huge amounts of cash. So I think they will bounce back,” says Putnam
Wright, at Investment Quality Trends, describes Franklin resources as “wildly undervalued.” To identify cheap dividend-yield stocks, Wright looks back in history to determine where yields repeatedly peak out. These historical repetitive high yields suggest where stocks look attractive. (Dividend yields rise as stocks decline.) For Franklin, the dividend yield has historically peaked at 1.9%, and it is has blown right through that, which makes the stock look even more attractive, says Wright.
Janus Henderson
Yield 6.1%
This company JHG, +0.61% tried to operate as a “merger of equals” with two CEOs after the investment shops Janus and Henderson combined in 2017. But that wasn’t working out. So the new plan is to let Dick Weil, who led a turnaround at Janus, run the operation, says Putnam. “This could be a catalyst for them,” he says. “He is likely to bring considerable improvements.”
The company likes to return lots of cash to shareholders; witness the rich 6.1% dividend yield. “So even if you have to wait awhile, you get paid to wait,” says Putnam.
Invesco
Yield: 6.4%
During the past two decades that I’ve written about the stock market, I’ve typically found the portfolio managers and analysts at Invesco IVZ, +0.00% to be insightful and competent, especially in biotech. So when insiders here stepped up to buy $650,000 worth of their own stock in February, I suggested this name in my stock newsletter. Invesco trades for a forward P/E of just 7.4 and it has good profitability metrics. The insider buying happened in the $18 to $19 range, which is where I suggested my subscribers should buy.
Eaton Vance
Yield: 3.5%
In Wright’s system, the shares of this money management shop EV, +0.91% look cheap whenever dividend yields hit their historical repetitive high level of 3%. The yield has broken through that level, which suggests Eaton Vance now looks especially cheap. Wright recently singled this company out by including it in his “Timely Ten” short list of favored stocks. One insider purchased $349,000 worth of stock at around $35 last December.
T. Rowe Price
Yield: 3.1%
This TROW, +1.35% is another investment shop which has especially insightful portfolio managers and analysts, at least in my experience of interviewing them for columns for years. By Wright’s system, this stock looks cheap when the dividend yield spikes to 3.1% and it now trades in that range.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested IVZ and EV in his stock newsletter Brush Up on Stocks, and he has a brokerage account at T. Rowe Price. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School in the Knight-Bagehot program.