Active or passive fund? It can be both
Investment styles complementary, say fund managers
The cheapest option could be the best for the least engaged KiwiSavers.
Fund managers should be tired of the 40-year debate over whether investors should back stock-pickers or index-trackers.
Thankfully, some of the arguments have been less barbed and there’s been an acknowledgement on both sides that it isn’t actually an either/ or proposition.
Put simply, there are just as many reasons to forgo the traditional route of picking winners as there are for ignoring a blunt index weighting.
Many advocates of one investment style are quite happy to use the other when it suits.
The products aren’t exclusionary and a number of investment specialists are comfortable using an index-hugging exchange-traded fund to get exposure to a broad theme for one component of their portfolio, while chasing that extra bit of cream with some active management.
Craig Lazzara, S&P Dow Jones’ managing director of index investment strategy, says the volume of trading in the United States shows a large number of active managers follow passive funds’ lead.
He says there’s no question that the investment styles are complementary, with the rise of passive funds weeding out the worstperforming active managers. Their performance is less volatile and they are also cheaper for investors.
“If active managers really believe that the growth of passive will lead to market inefficiencies, they should be happy because active managers make their return based on market inefficiencies,” Lazzara says.
Even Kiwi Invest — the investment arm of Kiwibank — toned down its usual criticism of index investing in a paper extolling the virtues of good active management.
It sees cheap passive funds as a better alternative to not investing. But it has more concerns about index funds that charge mid-range fees, or even worse, managers claiming and charging like active managers when they’re really just index-tracking.
Kiwi Invest backs itself to outperform as an active manager, saying the only role for passive investing is as a short-term option to keep some exposure to a certain theme or to rejig a portfolio in a cheap manner.
It applauds the pressure passive funds have introduced in bringing down costs and in setting a baseline for fees. Firms seeking anything above that base will need to show they’re worth it.
“Investment managers should ensure they are providing this value, and investors should ensure that they hold both active and passive providers to account.”
That will be welcome news for the Financial Markets Authority, which has a bee in its bonnet that KiwiSaver fees still haven’t come down, despite increased competition.
Its annual KiwiSaver review didn’t quite capture the effects of some more recent fee reductions, but it also seemed to prompt at least one fund manager to trim its fees.
The market watchdog is still banging its drum on fees, but wants to add nuance to its work by investigating whether KiwiSaver providers are delivering value for money. Within that, it will test the level of active and passive investment styles, and how they are being described to investors.
It’s actually a shame this work hasn’t already been done.
In the next month or so, Cabinet will decide what, if any, changes it makes to the default KiwiSaver framework ahead of tendering the next round of contracts.
The consultation document showed a greater willingness to use a life-stages approach for default funds rather than the current ultraconservative mandate. Officials also made it clear they expect fees to come down as a result of the work.
The decade-long bull-run in equity markets has meant default funds’ returns aren’t much to write home about, so containing costs is the most obvious thing the Government can address.
And given fees and taxes are the element most easily controlled by the Government, it follows that the cheapest option could be the best for the least engaged KiwiSavers.
There were almost 686,000 members in the nine default funds at June 30, with some $9.3 billion invested. Almost $2.5b was just cash sitting in the bank.
The average management fee seems steep at 0.52 per cent, especially given the nine providers share the automatically enrolled members who have helped the scheme swell to 2.9 million members over its 12-year history.
The cheapest is Booster’s default scheme at 0.38 per cent, although it’s a minnow with just $76m under management and 17,000 or so members. Its notable difference is that it uses index funds for about 40 per cent of the portfolio.
And that makes you wonder why making the default funds low-cost passive vehicles wasn’t put forward as an easy option for what will still be many Kiwis’ first step into the realm of investing.
That would also put acid on KiwiSaver providers to work harder to explain the benefits of other investment styles and help lift the understanding of the options.
And if that can help the country generate some meaningful long-term savings, I don’t think anyone would begrudge the providers sharing in those gains.