Active vs. Passive Investing in a Post-COVID World

As we begin to envision a post-COVID world, it’s likely that new investment opportunities will emerge within certain sectors. Though we’re still in the early stages of returning to normalcy, we’re hopeful for what the new economic cycle could bring.

In our recent webinar, Excelsior Capital hosted Cory Lester and Andrew Schmeelk of Morgan Creek Investments to discuss investment strategies for the new year and what alpha generation could look like in a post-COVID environment. Lester and Schmeelk partner with a variety of external hedge funds around the world and look to co-invest as actively as possible within the private markets. Their platform allows them to operate in the global construct- taking what they’ve learned in the public and private markets and applying that globally.

Topics from the discussion:

• Will the pandemic reverse the active-to-passive movement?
• Actively managing asset class exposures to manage expected return and risk vs. diversification
• Does active management outperform benchmark indexes in volatile markets, and do current market factors favor an active or passive investment strategy?
• How do investors quantify whether the risk management associated with active management is worth the higher fee?

Active vs. Passive Management in the Stock Market

With Morgan Creek being on the active end of the spectrum, Lester defined what active means to their firm- “making a conscious decision, in terms of overweighting or underweighting a specific sector or security.” When it comes to opportunity driven, active investments, it can be helpful to have a benchmark; for Morgan Creek investors, that is the MSCI Global Index.

On the other hand, Lester specified passive as being anything that is tied to a specific and established market in terms of tracking it. “Because it’s difficult to outperform long-only over time, with very few active investors that can be repeatedly successful over time, passive is favorable by most investors.” Two large companies that came up in discussion were Vanguard and BlackRock, both dominating the industry and controlling a combined $3.8tn of the $7tn global ETF market.

The next panelist, Shmeelk, shared that “one of the great advantages of active vs. passive investing in a market environment similar to the one we see today, is that when things are priced to perfection, this gives investors the ability to:

 

1. Be opportunistic,
2. Pick your sectors, and
3. Control your net exposure by being hedged.”

What Does Performance Look Like Moving Forward?

With the election behind us, Lester is hopeful for the future but is proceeding with caution, as are most investors. Now, more than ever, they’re looking further ahead to plan investments… to even 2026, 2030, 2040.

Lester’s main piece of advice: valuation matters.

As he indicated, “Over time, the S&P has compounded about 10% longer term. Looking at the last two years, the S&P is compounding at 23%. Taking into account the way averages work, you have to spend just as much time below as above. We’ve been in an extraordinary period of equity market outperformance versus the long term average over the last handful of years.”

The key factor to outperforming in the next part of the cycle is going to be “smart, high-quality active investing that can protect capital in volatile environments.”

As far as buying passive instruments, he advises investors to know what they own. “Looking at ETFs, they track indices that are cap-weighted like the S&P or price-weighted like the Dow. As those indices and stocks receive more flows and their prices go higher, you have concentration risks; the levels we’re looking at today haven’t been seen since the 90’s or early 2000’s.”

Themes and Emerging Trends

Lester discussed why it’s important to look at the long-short world, regardless of the overall macro environment. Here’s his perspective: Longs should go up by more than your shorts in a rising environment, and longs to go down by less than your shorts in a falling market. It’s all about the spread between these two sides in the balance sheet.

When it comes to looking at emerging trends, Morgan Creek investors believe that “cash flows are ultimately driving stock prices, and to look for broad-based themes that are secular in nature.”

Taking this into consideration, here are a few trends that Lester and Schmeelk are keeping an eye on, and some actionable ideas for investing:

 

1. E-commerce: (particularly outside of the U.S.) Alibaba, SEA Ltd., Coupang
2. Technology: SaaS companies, Microsoft, Amazon, Splunk, Cloudflare
3. Food Delivery: Drizly, Uber
4. Direct to Consumer: Ritual, Purple Innovation
5. Auto and Luxury: Carvana, Farfetch

What is Morgan Creek most excited about?

At the moment, Lester is looking forward to the E&P’s; Marathon, Occidental, and Diamondback Energy to name a few. If their thesis in energy and oil is right, there’s a lot of value to be unlocked.

Lester went in depth on his thoughts surrounding the energy sector, which he believes should see an upward trend by the end of this year and going into 2022. He discussed that, as the world normalizes, we should see an increase in travel due to the pent- up demand from the pandemic. The energy market, as a whole, has already begun to pick back up.

“Prior to the pandemic hitting, demand was around 100 million barrels, falling to 70 mid-pandemic, and now back up to low 90s. This shows us people will definitely shift back to travel as more of the population receives vaccinations. Even if people don’t rush back, there’s a good foundation for when they are ready to travel.”

To conclude, as we steadily make our way back into a stabilized market, investors should continue to prioritize valuation, keep in mind long-term goals, and observe emerging trends that will result from a post-COVID world.