Global equities – could 2025 be a vintage year for stock pickers?
Our fund managers seek to exploit market inefficiencies and believe active managers may have the advantage in today’s markets.
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Elevated valuation multiples, converging earnings trends between the “Magnificent 7” and the rest of the global equity market, and geopolitical uncertainty may add to sources of market inefficiencies that stock pickers can exploit. At the same time, a shift from a calm, trend-driven market could pose risks to passive equity strategies.
Alex Tedder (CIO Equities); Lukas Kamblevicius (Co-Head QEP); and Nick Kirrage (Head of the Global Value Team) recently sat together to discuss how they’re exploiting the market inefficiencies they see before them. Five of their key observations are highlighted here.
1. Three reasons for choosing active management in 2025
Lukas Kamblevicius: We all know that passive investing is a cost-effective way to gain exposure to equity markets. It tends to work well in a calm, trend-driven market environment. If anything, at the current juncture of the markets, investors might want to consider an active approach. Valuation multiples are quite high across all regions, primarily in the US, but equally so in some other pockets of the world. Meanwhile, index concentration is increasing across multiple regions and volatility has picked up so far in 2025. Combining all those three components together, one would advocate that risk management and an ability to tilt away from more concentrated, more valuation stretched pockets to other portions of the market could be prudent. Looking ahead, we think an active approach will be required to navigate these risks.
US has driven market concentration to a four-decade high...
…but US market is still not unusually concentrated by global standards
Note: On the left-hand chart both the MSCI World and the MSCI AC World indices are included as the former has a longer history while the latter incorporates emerging markets.
Source: LHS: LSEG Datastream, MSCI and Schroders. Data to January 2025. Index: MSCI AC World index and MSCI World Index. Data is monthly with each data point reflecting the percentage weight of the largest 10 stocks in the mentioned index at each respective date. RHS: MSCI, as at January 2025.
2. The Mag 7 are facing short-term risks
Alex Tedder: The Mag 7 are not a homogenous group; each operates very differently, they have different product sets and different priorities. Microsoft is not Apple or Amazon; Google isn’t Meta; Nvidia isn’t Tesla. But the Mag 7 do share one common denominator, which is artificial intelligence (AI). They share a common interest in advancing their platforms through the deployment of generative AI models – essentially revolutionising the process of interaction between humans and computers. Optimism about the implications of this revolution has significantly influenced their stock prices, providing a common performance driver despite the variations in their respective businesses.
At this point the key question is, are investors ahead of their skis? Are they too excited about the AI theme and not thinking about the reality of translating new technology into hard dollars? It's relevant because doubts are creeping in. The doubts are focused on the idea that these companies are spending a ton on AI, and yet the short-term revenue benefit and profit benefit is actually very limited. There is a legitimate concern here. The structural potential from AI is clearly enormous, but actually in the short term, I suspect there'll be major disappointment at some points. New technologies rarely deploy in a straight line: they take time to build, and there are inevitably speed bumps along the way. I think that may be where we are now. A period of consolidation, and possibly some real disappointment later this year if demand for AI infrastructure (semiconductors, network equipment) begins to weaken.
Read more about the implications of uncertainty around AI and the market here:
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3. Taking the harder route to get ahead
Nick Kirrage: We’ve been going through an extremely challenging period of history for many active managers. We have seen this rise of passive investing and perversely, for the first time in a very long time, those biggest companies have actually been doing better. The cheapest passive products that buy all the same stocks are also the ones that in many cases have made you the most money. In reality, what most of us know is life's not that easy. Over the long term, the harder choice, the harder road, the harder work, typically is the way that you get ahead in all aspects of life. Investing, I believe, is the same. But we've got a job, I think, as active investors to make that point and to prove it through our returns. Additionally, our new research into changes both in the structure and participants in stock markets suggests that there may be greater opportunities for active managers to outperform in the future than in the past.
Read more on the active versus passive debate: How the emergence of new investors creates opportunities for active to outperform
4. Concentrated markets – opportunities and challenges
Alex Tedder: I have had some of the big tech names, purely because of conviction in what they do, in the business models and in their ability to sustain growth for quite long periods of time (see 'Market inefficiencies and "positive growth gaps" section, below). This has played out quite nicely, and from a style standpoint the environment has helped me as these companies have grown very large. Can that environment continue? Based on history, almost certainly not. When you get to this degree of concentration, which currently is more than 30 per cent of the US market represented by a handful of stocks, historically the market has always broadened out. Those very large companies, as a group, have done relatively less well. Some of them may continue to power ahead, but the law of large numbers dictates that others will struggle to sustain growth and may even begin to decline. I think we're about to come into that phase. Given that many areas of the equity market have been neglected amidst the euphoria around the AI revolution, a broadening out is an opportunity for active managers.
Market inefficiencies and "growth gaps”No matter which region of the world or economic sector of the market, companies that deliver revenues, cash flows and ultimately earnings above the level anticipated by the market are well placed to deliver superior share price performance over time. This idea forms a key tenet of the investment philosophy of Schroders' fundamental global equity team. They believe that fundamental stock research and analysis should focus on identifying those companies able to deliver positive earnings surprises, or which have a positive "growth gap", which the market often fails to recognise. Even in the most efficient market in the world (the United States) these inefficiencies with respect to future growth are prevalent and often persistent, as the recent Nvidia experience clearly demonstrates. Typically, higher growth characteristics are eventually recognised by the market, which often places higher valuation multiples on those earnings at the same time. |
5. The value perspective on the AI theme
Nick Kirrage: I think AI is going to become endemic, and as it gets more and more powerful, it's going to become a bigger part of our lives. But alongside those huge leaps, you do get the huge hype. Trying to separate those things, I think, is very important. I think about this last year, when the hype around Nvidia was at its peak. As a value investor, we wouldn't have bought Nvidia at those kind of levels and we try and find other ways to make those returns. The way that we did it last year was by buying a stock called Hon Hai, otherwise known as Foxconn, and they are one of the largest outsourced manufacturers of Nvidia's chips. The stock benefited from Nvidia’s tailwind but was very cheap and very left behind. Can we find ways to exploit some of these trends? That's what we're thinking about.
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