Jupiter's Merlin team have warned investors should keep away from passive vehicles in the current investment environment, amid liquidity concerns and overinflated valuations.
Algy Smith-Maxwell (pictured), a manager on the Merlin team, said investors are being encouraged to put money into passive vehicles, but they should be wary of making such a commitment at a time when central banks across the globe begin to unwind their monetary easing programmes.
He said: "We may well be entering a period when investors have the wind in their faces. An active manager's job is to protect returns and limit the downside [during these periods].
"This is the most important time for investors to be backing away from passives."
ETF inflows in the first quarter of 2017 hit a record $189.1bn, far outpacing the previous record of $137.8bn reached in Q4 2014.
However, the Merlin team have cautioned that investors in passives are susceptible to market downturns, while active investors can try to avoid losses during times of market stress.
Smith-Maxwell pointed out the stocks which increased the value of the S&P 500 index by $269bn between 1 March and 9 May were all technology stocks - Facebook, Amazon, Netflix and Google, or the so-called FANGs. Yet, overall, the stockmarket has remained largely flat over the period.
John Chatfeild-Roberts, who heads up the team, also warned on the valuations of technology stocks, saying Amazon is trading on a historic P/E ratio of 180x earnings.
"So you would have to be a great believer in what they can do in the future to invest [in it]," he said.
While an active manager can add value by avoiding stocks with such high valuations, he argued passives are fully exposed to the tech sector, and therefore pose risks in case of a downturn.
Chatfeild-Roberts said: "FANG stocks could still double in value, but historically, mean reversion tends to come eventually."
He also used the example of Vodafone, whose share price has more than halved since 2000, saying active managers who made the bet not to hold the telecom giant in their portfolio are now "vindicated", while passive vehicles could not avoid it.
Meanwhile, Smith-Maxwell expressed concerns about the liquidity in ETFs, saying his team had previously struggled to get out of a high yield index tracker quickly.
"When investing in ETFs, what is the liquidity going to be like when the exit door gets really narrow? I am very worried about ETF liquidity," he said.
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