Wi is Towers Watson Asset Manager Review

IN framing their default investment strategies, Defined Contribution funds will be required to “consider” both passive and active approaches. Do you think this will give a boost to passive and similar strategies in South Africa, or is this requirement too weak to have any effect? And is this an “either/or” choice – or otherwise how could active and passive strategies be blended?

Natalie Phillips, head of institutional at INVESTEC ASSET MANAGEMENT says the fact that the default regulations allow members to consider both options, will likely encourage retirement fund boards to consider the costs and benefits of both passive and active solutions.

“While it is possible to blend active and passive strategies, we believe a bias to active strategies is appropriate, particularly in the South African market where the current indices are not representative of the full investment opportunity set. There are also significant distortions such as the dominance of a company like Naspers which comprises over 19% of the All Share Index, exposing passive investors to significant risk.

“A focus on passive strategies risks missing out on assets like corporate credit, which has delivered fantastic returns over the past 10 years and continues to grow. Local issuers of corporate credit often have a stronger balance sheet than the government fiscus, providing opportunities to reduce risk and improve returns compared to a passive strategy tracking the All Bond Index.

“We believe passive strategies can be used tactically and/or to reduce costs but our market is too small to simply follow a pure passive approach,” says Phillips.

Nadia Van Der Merwe, business analyst, at ALLAN GRAY says it is difficult to forecast the exact impact of the requirement to ‘consider’ both active and passive strategies, since neither is clearly superior. One needs to consider the approach taken to add value for investors and the manager’s longterm success in doing so.

“Philosophically, both active and passive have benefits and potential drawbacks. Further, we do not think that it is an ‘either/or’ choice; both could be combined in a default offering. The appropriate blend of active and passive will ultimately depend on the fund’s member profile and risk tolerance, as well as the investment flexibility permitted within the underlying portfolios. It is imperative that trustees understand the nuances of the selected strategy and potential impact on member outcomes.

“While we acknowledge that there is a place for passive in certain instances, several active managers have historically added enormous value for members and should continue to do so over the long term, particularly in a concentrated market like the JSE,” says Van Der Merwe.

Sara Herbert, head of investment consulting at OLD MUTUAL CORPORATE CONSULTANTS says a well informed and advised Trustee Board will already be considering both active and passive strategies when determining their default investment strategy.

“When considering an active vs passive approach, the focus should be on cost vs value - net returns, rather than just costs. Of particular importance in the selection of a default is the volatility of the portfolio.

“The nature of index tracking mandates is that they move with the market and thus experience full market volatility. The nature of many South African indices is that they carry single stock concentration risk which can increase volatility.

“It’s also essential to consider the indices that are being used as a benchmark, whether active or passive, as this can have a bigger impact on outcomes than any differential in the fees between active and passive.

“A final comment is that, whether you’re choosing active or passive, it’s essential to ensure that the provider is competent and provides a high quality solution. An active manager that can’t add alpha is problematic but so is an index tracker who can’t track the index closely. Many clients already invest in an investment strategy that includes a mix of active and passive strategies both domestically and internationally,” says Herbert.

Charles Booth, chairman of investment committee and portfolio manager at TRUFFLE ASSET MANAGEMENT believes the attraction of passive investing is very powerful, however, it must be considered in the light of active managers’ fees.

“The simple reason why passive strategies are so attractive is that active managers have, after fees, not beaten passive indices in most markets. This largely stems from the fact that markets almost everywhere are becoming more efficient. As investors are getting more professional and more informed it is becoming more and more difficult to act in a contrarian way. But, as active managers’ fees fall (and there is currently huge pressure on fees) the advantage that passive managers have erodes.

“I believe that there is room for both active and passive managers and that an equilibrium will be reached where the fee premium charged by active managers will reduce to the point where they will become competitive. It is worth noting that an increase in the passive pool of funds improves the opportunities for active managers i.e. both need each other.

“From as funds’ point of view I think that a Core and Satellite approach is the most sensible. That means that the core of the (equity) Fund should be managed via passive strategies and active satellites should be used only where inefficiencies can be exploited.

“With regard to asset allocation passive strategies have been overwhelming shown to be appropriate,” says Booth.

Danie van Zyl, head: guaranteed investments at SANLAM EMPLOYEE BENEFITS says most funds have already moved away from the binary view that a default investment strategy should be either active or passive.

“There are advantages and disadvantages to both strategies, with a passive strategy better suited to certain asset classes than others. We believe that the requirement to consider both active and passive is forcing trustees and their consultants to pay more attention to which asset classes one should manage actively or passively (or both).

“In the Sanlam Lifestage Accumulation Portfolio, used as a default investment strategy by our umbrella fund, we manage our local bond exposure on an active basis as we do not see the value-add of passive for this asset class, however in our local equity exposure, half of the exposure is managed actively and half passively.

“Meanwhile, our local property exposure is fully actively managed. The end result is far more nuanced than an either fully active/passive view. We find that most good investment consultants are already advising their clients in a similar manner,” says Van Zyl. Neo Mokhesi and Litha Madabane, trainee investment analysts at ARGON ASSET MANAGEMENT say passive investing, also known as index tracking, is not very popular in South Africa and commands a far smaller market share than the global passive market.

“We don’t think this requirement will change that since the reasons for its unpopularity are largely entrenched in the South African market. Firstly, the SWIX Top 40 Index has a higher annual turnover than passive indices in the US and elsewhere.

As a result, South African index-tracking costs are relatively high, since passive managers must rebalance their portfolio holdings more frequently.

“The second reason is that the South African equity market is quite concentrated, which makes passive strategies less efficient on a risk-return basis. Lastly, the small and illiquid nature of the South African market poses challenges to quasi passive quantitative strategies (often referred to as smart beta). These strategies work better internationally where they can average over thousands of stocks

“Generally passive strategies do work well internationally and are more affordable. A blended approach of local active strategies and global passive strategies will therefore be most effective,” say Mokhesi and Madabane.

Paul Cluer, managing director at FOORD ASSET MANAGEMENT says passive investment products should of course be considered for single-asset class investment strategies. Unlike global markets, concentration risk in the South African markets advocates against wholesale use of passive strategies, especially when the best fund managers have sustainably outperformed market indices over the long term.

“Costs (especially trading costs associated with portfolio rebalancing) should be carefully analysed, monitored and disclosed as many optically-cheap products can be quite expensive. The shortcoming of passive investment strategies is that they’re not especially passive: the asset allocation decision must still be made and this adds or subtracts significantly to long-term savings growth; and the selection of which passive product or strategy to adopt initially is an active decision that carries risk.

“The absence of real, auditable, long-term, multi-asset passive strategy track records should make trustees cautious when considering such products for the default portfolio,” says Cluer.

Dr Adrian Saville, founder and CEO of CANNON ASSET MANAGERS says there is a furious debate raging in the investment industry – not just in South Africa, but globally – that pits active against passive. Each case has merit and our perspective is that the most sensible approach is not “either or” it is rather “both”.

“To add to this, modest adjustments to a passive investment approach can capture active elements, meaning that from an investment perspective there is the prospect of a ‘free lunch’,” says Saville.

Dr Fernando Durrell, head: multi-asset at VUNANI FUND MANAGERS says he expects that it will increase interest in passive strategies.

“In particular it is possible that we will see specialist passive funds used to construct multi-asset fixed ratio or dynamic ratio portfolios. The increasing concern about costs that we have seen in the industry is that manager of active strategies will have a harder time motivating for the inclusion of active approaches as defaults.

“This could result in a bifurcation in schemes where more sophisticated members chose active strategies while trustees offer lower cost passive strategies for members who are not sufficiently well informed to opt for an active option,” says Durrell.

Batsile Ngomane, head of strategic initiatives at ASHBURTON INVESTMENTS says while the company utilises both active and passive strategies in crafting its investment solutions, the extent of the use of either active, passive or alternatives assets is informed by which path enables it to achieve the targeted risk adjusted returns within the required time horizon and in the most cost efficient manner.

“Our investment framework therefore allows us to seek efficient sources of return from different investment strategies – passive (including smart beta), active, alternatives or combination. The factor framework we adopted assesses those styles of management that contribute meaningfully to the efficient harvesting of risk premia.

“This approach provides an equal chance for all investment management styles and approaches to form part of the solution.

“We, therefore, do not believe it is an either-or choice but more the application of the principles in developing investment solution that best meets the retirement goals of members on a risk-adjusted and cost-efficient basis,” says Ngomane.

Asief Mohamed chief investment officer at AEON INVESTMENT MANAGEMENT says the word “consider” will encourage trustees to apply their minds not just only to pure low-cost passive strategies but also to semi-passive strategies. The “under” performance of about 75% active strategies over a five or longer period will inevitably result in trustees considering passive and semi-passive strategies.