Carillion's crash shows the value of studying the firms in which we invest

Julian Harris
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Construction stocks have come under pressure (Source: Getty)

Fund managers have been under the cosh of late.

On this side of the pond the sector faced intense scrutiny as part of a City watchdog investigation which found evidence that “price competition is weak in a number of areas”, with funds often failing to report their performance against an appropriate benchmark.

Meanwhile the industry is beset by an existential dilemma as bigger and bigger flows of cash move away from active investors and towards increasingly popular passive funds.

In the US more than a third of assets are now in passive funds, according to Bloomberg, with a $500bn flow from active to passive in the first half of this year.

The reasons behind such flows – insipid returns often failing to outperform the FTSE or S&P, for example – are understandable, while in London the sector's fees and level of transparency were long overdue a shake-up.

Read more: Carillion shares have fallen 40 per cent after chief executive quit

However, we should beware too strong a move away from active investing. The case of Carillion, which sent shockwaves through the City yesterday, demonstrates the value of an investor who pays close attention to a company's balance sheet.

The full extent of Carillion’s woes was unclear until yesterday’s astonishing statement, yet some traders had been suspicious for a while, helping the stock fall from over 300p a share last August, to 192p at the close of play last week.

The size of the company’s dividend had seemed absurdly ambitious for some time, with its debt pile and pension deficit looking ominous.

Some fund managers stuck with Carillion, of course, and have paid the price. This is how a market should operate, with the opportunity to win or lose depending on the quality of one's information, and analysis of that information – plus the odd slice of luck.

Indeed, markets rely on this trading of close analysis and opinion.

The active fund management industry is far from perfect, but we must remember that there is value in having a large number of people keeping an eye on public companies and acting on their findings. Money should flow towards the stock of businesses based on their performance, not simply on their membership of some or other index.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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