August 30, 2011
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Doing well in an uncertain economy can be a tricky tightrope walk. Wild market swings often get the better of investors’ emotions. In the week following the S&P’s August 5th decision to downgrade the long-term U.S. credit rating from AAA to AA+, fluctuations plagued the market, with the Dow Jones Industrial Average spiking 4% higher one day only to drop 4.2% the next. And in an unprecedented move, the market recently witnessed four triple-digit swings in a five-day period.
It’s been an eventful few weeks, to say the least. The market volatility reminds us that active investment management is more crucial than ever.
These events come at a time when many investors have moved away from active management in favor of an index-based, “risk-on, risk-off” approach. They’re either in a market sector or out of it altogether, without trying not to pick individual names. While passive index investing has merit under many circumstances, we believe the current climate of economic stress calls for an active approach.
Making sense of the chaos of volatile markets takes skill and experience. Qualified active managers possess acute knowledge of the stocks that could outperform in shaky markets and can keep a lookout for companies with sound fundamentals that may be available at depressed valuations.
When the market is highly volatile – whether up or down – correlations rise. But the rise is temporary. Eventually, as emotions ease, asset prices find their own levels again.
The same is true of individual securities. Although the market may be in rough shape for a time, there are still current opportunities in the equity and fixed-income space. A good active equity manager will likely steer investors toward large-cap opportunities relative to small-cap names, because larger companies will, on balance, have greater financial strength to help them weather economic uncertainty. Likewise, active managers will favor growth stocks over their value counterparts in the current environment because companies that are able to deliver sustainable growth have historically traded at a premium during periods of slow overall economic growth. The defensive sectors — such as consumer staples, telecom and utilities — should do well, as should companies with higher dividend yields. Many active managers find companies with a demonstrated ability to consistently grow dividends especially attractive.
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