Asset managers and established Wall Street players expect new market paradigms to drive more investors to consider active management. But what should investors and advisors look for when diversifying away from major indexes?
VettaFi contributor Dan Mika spoke with Brian Weinstein, Morgan Stanley Investment Management’s head of global markets, about how the firm thinks investors should dip their toes into active management.
The following interview has been edited for clarity and brevity.
Dan Mika, VettaFi: We’ve heard for a very long time about this larger debate over active management versus passive management. What are some of the larger macroeconomic factors Morgan Stanley has identified that led it to revisit this idea and not necessarily follow indexes as the entirety of an investor’s portfolio?
Brian Weinstein, Morgan Stanley IM: We just came out of the decade where the macroeconomic factors weren’t the driving force. We had a Fed on a mission, the global central banks on a mission to re-liquify after the great financial crisis, which seems like a long time ago. But I think it’s been a predominant theme. You’ve seen all this money come into passive and obviously drive certain things higher versus others. But when you look at what’s happening now, you get a lot more dispersion. We think about the Bank of Japan hiking when the Fed is easing as an example. You’re just going to start to get different outcomes. That points to the idea that this massive flow into passive has lifted lots of boats. But it doesn’t mean it will lift all boats forever.
You need to have some other things in your portfolio depending on your worldview. They could be European things, emerging market things, global things. It could be U.S. growth equity. That’s been working. But you have to have a little bit more of a view in your portfolio to balance out the fact that the world has a little bit more dispersion in it than it did in the last 10 or 15 years.
VettaFi: Why go with active ETFs versus adding smaller, more focused index ETFs to a portfolio? You can definitely diversify by just having more concentrated indexes. Why is it more important now to be making these decisions?
Weinstein: I think there are lots of ways you can diversify your portfolio. The question with an index is, how should an index be weighted? Look at the S&P 500. You get 30% of the index in pretty much seven equities. It probably happened once in energy. It happened once in financials in the last 20-odd years. And it turned out you didn’t want those. You can equal-weight. Well, equal-weight says, I’m not going to think about it. Or you say, I’m going to take a momentum factor or something.
You can generate returns in those things. Or you can say, there’s people out there that are spending a lot of time and energy doing deep analysis for me. And maybe there’s a time where the data that builds an index isn’t the right way to do it. But I would assume that as people move out of passive in both fixed income and equity, they’re going to do a mix of those things. They’re not going to give 100% of their money to one manager because they think they’re smart. There are lots of interesting ways a client can diversify away from the broad indices that capture most of the money. I think that’s a fair comment in both fixed income and equity. And there’ll be multiple ways investors can win and lose. You have to go back to those macro factors and get them right.
I guess a different answer to your question would be: Morgan Stanley, and other firms like it, spend a lot of time following these trends. Most people probably have day jobs and they don’t have time to necessarily get deeply into it. That’s where active management, I think, can really shine during times of dispersion. These things can change. And you need your manager to change with it, if the market is dynamic.
VettaFi: On that point about active managers and identifying good managers. This note does say there’s room for active and passive to coexist. But I’m wondering what factors should be considered when you’re looking either as an individual investor, looking at portfolio managers, or if you are a financial advisor, looking on behalf of your client. What factors in an actively managed security — or in a portfolio manager — shine. In particular, I’m interested in factors that aren’t quite obvious like the client’s risk tolerance or their time horizon.
Weinstein: One of the things I think Morgan Stanley does somewhat differently than many others is, you’ll see with the Morgan Stanley name or the Eaton Vance name, those funds are all run by different teams.
In other words, there’s no Morgan Stanley Investment Management house view that says everyone should be long the tech sector, or just to pick something easy. Different fixed income teams, or the growth teams, equity [teams], or whatever you want to choose, all do their own research. And they come up with what they think is best for what their client is trying to do.
There are three ways to invest in this market.
One is you’re algorithmically driven, which, let’s be honest, is not most investors reading this. They’re the people that can change their minds every day; they’re machines. They see small signals. They’re trying to make a couple pennies here and there. You have plenty of firms which we can name that are trying to do that.
The second thing: I’m going to do passive; I’m just going to set it and forget it. That’s been very popular and very profitable in the last couple of years.
Third is to say, I’m going to pick a manager with skill. And how do you find that? One is longevity. How have they done over time, and what’s their volatility? In other words, hopefully these investors aren’t coming in here, because between now and the end of the year, they know what’s going to happen. That’s a pretty tight time frame. I think our investment teams, generally speaking, have very-long-term views, and they will change them as the markets change. But a Fed cut here and there, or whether the Fed cuts in September or December or doesn’t cut at all, these aren’t the things that are going to drive the major parts of portfolios.
You want independent thinkers who are doing deep research, who’ve done it for a long time, seen market cycles. And you can go back and look at how they’ve done in those cycles. That’s how we’ve always built our investment teams.
So again, it’s hard for me to say, without knowing everyone’s individual portfolio, what risks they should be taking. But if you want to be in and out tomorrow, that’s what passive is for. You don’t need an active manager for that. If you want to think about what the world looks like at the end of 2025, then you can start to think about real good active management. We’ve had this past decade or so where central banks have been trying to recapitalize the markets. And it’s just been really easy to be a passive investor and to get a really good return by just setting and forgetting a portfolio that way.
VettaFi: What advice would you give to financial advisors when they are reintroducing longer-term clients, or maybe introducing for the first time to new clients, the idea of active management after this long period where indexes have done so well?
Weinstein: Let me take two themes for you. I’m going to do a fixed income theme and equity theme.
The fixed income theme to me, how did the central banks recapitalize the markets? They lowered rates and that there would be a lot more debt. You and I can have another hour-long conversation on whether it’s too much Treasury debt or too much high yield debt or too much bank loan debt. It doesn’t matter. There’s a massive amount of debt in the world versus what was around 10 years ago.
The fixed income indices give the most weighting to the countries or companies or governments with the most debt. So I think it’s a very simple conversation in fixed income: What is most likely to default? You’ll get some really small defaults, like small companies. But the big ones that matter are the ones with the most debt. So you don’t want to bypass the fixed income. Dispersion is going to cause default cycles to go up. The central bank will not always be able to save everybody. To me, active fixed income is the obvious one, because, very simply, the index is built in a way that investors would obviously want to avoid. You need someone doing research. There’s tens of thousands of CUSIPs. You don’t want to trust the index for that.
See more: Use Active ETFs to Benefit From High Yield Bonds
On the equity side, I think it’s harder to convince investors because it just looks so good to keep chasing what’s worked. You have a big drawdown [recently] and then it bounces back with the same seven equities. I think the thing you have to remember about equities is these themes move in these waves. It’s never obvious when the wave is over until you look back at it and go, wow, I really rode that thing down way too far.
You can pick any name you want. If you bought Nvidia 15 years ago, you’re rich. It can’t do that again, right? So Nvidia could go up in price from here. It could double. But the days of those seven equities having multiple hundreds of percents returns are over.
So the question you have to ask yourself is, whatever portion I captured, how do I start to take the profits and think about what’s going to be next? Where’s the next big wave going to start?
Active managers, having some diversity and having a few different thoughts on where that might come from, allows you to take your profits and not ride that wave down when it comes. … The technology companies of 30 years from now are unlikely to be the technology companies of today.
Great companies like AT&T and the like, they were going to take over the world, right? They’re still around, but now they look more like utilities. I think that’s how you think about equity. You don’t want to chase something that’s gone up 2,000%. You want to take what you can and think about what the next big moves are. That’s where these thoughtful active investors who are trying to think about the world in a different way come into play.
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