Volatile outlook for stocks could benefit financial pros

Stock prices are likely to be more volatile in 2017 than in recent years, money managers and analysts said at the Star Tribune's annual Investors' Roundtable, a change that should benefit financial pros like them.

For several years, individual investors have increasingly steered away from mutual funds and other investments that are run by professional money managers and turned instead to lower-fee index funds that simply track broad segments of the market.

Through the first 11 months of 2016, a record $286 billion was pulled out of actively managed investments and $429 ­billion poured into passive ones like index funds, Morningstar reported last month. Still, more money is invested in active strategies than passive.

"Its very fair to say that the passive investment theme through ETFs or index funds is certainly the flavor of the day," said Roger Sit, chief executive of Minneapolis-based Sit Investment Associates and a participant in the roundtable.

His firm has 14 actively managed mutual funds and one exchange traded fund, the Sit Rising Rate ETF, which is designed to help investors hedge against rising interest rates.

"There is a point in time when passive does better than active," Sit said. "The keys appear to be the predictability of when there will be uncertainty and volatility," Sit said.

Sit is biased toward active management but believes there is room in portfolios for both active and passive strategies.

The appeal of passive investments has been aided by the low volatility environment that was a by-product of extraordinary monetary policies of central banks in the United States, Europe and Japan in recent years to ­prevent a recession.

But that environment is changing as the Federal Reserve takes the lead in raising interest rates. As well, the arrival of a new U.S. president brings the prospect of greater swings in prices of stocks and other investments as investors adjust to different priorities and policies.

"We're going to have a little more volatility but more confidence associated with it, and I think that could help active" investments and managers, Jim Paulsen, chief investment strategist for Wells Capital Management, said at the roundtable discussion held last month at the Star Tribune.

Passive investment strategies began in the mid-1970s with John Bogle's Vanguard Group, one of the earliest proponents of index-based funds. For years, they appealed chiefly to individual investors. But data shows that employer-sponsored 401(k) plans, public pension plans and endowment funds are all devoting more money to passive strategies than they have in the past.

The trend of more money moving toward passive accounts has had an effect on local firms, including Minneapolis-based Piper Jaffray Inc.

"Company management believes that these net outflows are the result of an extended cycle of investors favoring passive investment vehicles over active management, combined with certain investment strategies having performance below their benchmarks," the company said in the filing.

Tom Smith, chief strategy officer of Piper Jaffray, said the charge has no real impact on its bottom line and the firm is committed to the asset management business. "We like the business as part of our mix," Smith said. "It's a noncash charge and not reflective of the business itself. It's just an accounting ­determination."

Smith calls the recent environment a "low dispersion market" in which the average stock moved about the same as the overall market. That will change as interest rates rise, he said.

"In a higher, more normalized interest rate environment, you'll start seeing more dispersion," Smith said.

Investors who rely on more active management of their holdings are likely to fare better than passive investors when there is more dispersion.

Sit said he doesn't expect to follow Fidelity's example.

"We add products if we think we can leverage our core competency," he said. "Our core competency on the equity side is growth equity, high-quality investing, focused on fundamentals."