Home / Equities / The golden age for active management in Australia

At a time when the asset management industry seems to be gravitating inexorably toward passive investing – with low-cost ETFs pulling in record inflows and active managers nursing bruises from underperformance – Tim Carleton, chief investment officer at Auscap Asset Management, offered a bold counter-narrative at the Investment Leaders Forum in Byron Bay.

Equities

His message was clear: now is precisely the moment to go active, especially in Australia. His reasoning, steeped in earnings logic and valuation discipline, drew a sharp contrast between the structural dynamics of global indices and the idiosyncratic opportunities within Australia’s market.

Carleton began by painting the big picture – a world awash in passive capital. “BlackRock alone attracted one trillion Australian dollars into passive last year,” he noted, underscoring a wave of capital gravitating toward simplicity and cost efficiency. But, as he pointed out, this shift has coincided with a historic stretch of active manager underperformance – with many trailing their benchmarks by over 4.5 per cent in 2023. And yet, Carleton argued, this very underperformance is laying the groundwork for a reversal.

The core of his thesis rests on a timeless axiom: over the long term, earnings drive share prices. “Stretch the time horizon and the only two things that matter are dividend yield and earnings growth,” he stated. This is not a new insight – but Carleton’s framing of how passive and active strategies intersect with earnings growth is where the argument becomes compelling. Passive investing thrives when the largest companies in a cap-weighted index are also the ones growing the fastest. In the US, that condition has been met for the last decade, as the ‘Magnificent Seven’ dominated both size and performance.

Indeed, the numbers are stark. The S&P 500 rose 247 per cent over the past decade, but only 22 per cent of stocks beat the index. Active managers who weren’t overweight the Mag-7 were essentially doomed to lag. “It’s been very, very difficult,” Carleton admitted. But the flip side of this dynamic, he argued, is now manifesting in Australia – a market that structurally favours active approaches. Why? Because the largest weights in the S&P/ASX 200 benchmark – financials and materials – are precisely where earnings growth looks weakest.

A third of the Australian market sits in banks, Carleton pointed out, yet these institutions haven’t grown earnings in a decade. Worse still, they’re now trading at historically high price-to-earnings multiples. “It’s probably the worst outlook we’ve ever seen since they listed,” he said. And despite cost-cutting and branch closures, the majors are steadily losing share to Macquarie, which combines a leaner cost base with a better tech stack. “If we’re sitting here in 10 years, Macquarie’s market share will likely have tripled,” he predicted.

Resources, the other heavyweight sector, is similarly under pressure. Carleton noted that China’s consumption of iron ore peaked in 2020, and demographic and debt dynamics suggest a return to more normalized demand. “They’re consuming more steel per capita than virtually any country in history – that’s not sustainable,” he said. With supply ramping and demand set to contract, margins in mining look set to compress. And for those hoping India will fill China’s shoes, Carleton had a simple rebuttal: India consumes less than one-fifth the steel China does.

This structural setup – overweight sectors with flat or declining earnings prospects—creates a fertile ground for active managers to differentiate. “If you believe that long-term earnings drive share prices, this is an extraordinary opportunity,” Carleton said. He distinguishes sharply between genuine active management and “quasi-active” strategies that hug the index. Outperformance, he argued, will come from the other half of the market – the parts not shackled to financials and materials.

That, in Carleton’s view, is where Australia’s mid-cap segment comes into play. Often overlooked in favour of blue-chip defensiveness or small-cap speculation, mid-caps have been the quiet outperformers of the ASX. Over the last 25 years, the ASX MidCap 50 has delivered superior returns to both the ASX 20 and the broader market. “The reason is simple,” he said. “They deliver better earnings growth.” These companies tend to dominate niche verticals, operate with efficiency, and grow steadily without the pricing risk that plagues unproven small-caps or saturated large-caps.

Even in the last decade, with commodity supercycles and bank re-ratings propping up the index, 40 per cent of stocks still outperformed. And among SMID active managers – those playing in the mid- and small-cap space – 84 per cent beat their passive benchmarks. That success rate is poised to rise, Carleton argued, as the distortions of the last decade unwind.

At a moment when so much capital is flowing to market-weighted ETFs, Carleton’s thesis is a reminder that benchmarks are not static indicators of opportunity. They are reflections of structural bias – tilted today toward size, not necessarily toward earnings or value. “The next decade will belong to active managers,” he concluded. “Because the opportunity set is finally shifting in our favour.”