PAS­SIVE PAYS OFF

Pas­sive funds have been per­form­ing well, but it would be a mis­take to ex­clude ac­tive man­age­ment, writes Stafford Thomas

Financial Mail - Investors Monthly - - Contents -

Pas­sive man­age­ment may be crow­ing at present but ac­tive eq­uity man­age­ment is far from be­ing dis­carded

The fail­ure of most ac­tive eq­uity man­agers to beat the mar­ket in re­cent years has left cham­pi­ons of pas­sive man­age­ment crow­ing tri­umphantly.

How­ever, while ac­tive eq­uity man­age­ment may be down, it is far from out.

Right now the pic­ture for ac­tive man­age­ment as a whole looks bleak. A Stan­dard & Poor’s (S&P) anal­y­sis gives pas­sive man­age­ment back­ers am­ple rea­son to feel vin­di­cated.

S&P’s anal­y­sis, the S&P (SA) In­dices Ver­sus Ac­tive Funds Score­card, makes grim read­ing. In the do­mes­tic eq­uity unit trust sec­tor alone only 16,3% of funds beat their bench­marks in the 12 months to De­cem­ber 2014.

Over three years 17,9% of funds out­per­formed while over five years a mere 15,3% did.

It makes for a com­pelling rea­son to opt for an in­dex-track­ing unit trust or ex­change traded fund.

Or does it? In an eq­uity bull mar­ket now well into its sixth year, in­vestors should think twice be­fore rush­ing head­long into pas­sive eq­uity funds.

What they will be get­ting in an in­dex tracker fund is “huge com­pany-spe­cific risk”, cau­tions Louis Nie­mand, Investec As­set Man­age­ment in­vest­ment di­rec­tor.

Put another way, in­vestors opt­ing for SA eq­uity in­dex track­ing funds are tak­ing an ac­tive de­ci­sion to have ex­po­sure to a high-con­cen­tra­tion risk.

Re­flect­ing this, the 160-share JSE all share in­dex (Alsi) is topheavy in the ex­treme, the top five com­pa­nies — Naspers, SABMiller, Bil­li­ton, Richemont and MTN — weigh­ing in at a com­bined 38% weight­ing. The next five take the to­tal to 53%.

This is un­like ma­jor for­eign eq­uity in­dices, where track­ing comes with far lower con­cen­tra­tion risk.

In the 500-share US S&P 500 in­dex, for ex­am­ple, the top 10 com­po­nents have a com­bined weight­ing of 17%.

The big­gest S&P 500 ex­po­sure is to Ap­ple at 3,9%, fol­lowed by Mi­crosoft at 2%. In the Alsi, Naspers weighs in at 9,9% and SABMiller at 9%.

“An ac­tive man­ager with these lev­els of ex­po­sure could be ac­cused of tak­ing too much risk,” says Nie­mand.

But with­out a full weight­ing of Naspers in an ac­tive fund, beat­ing the mar­ket has been a tall or­der. In the 12 months to June the Alsi re­turned 4,8%, with Naspers’s 51% rise ac­count­ing for over three quar­ters, says Nie­mand.

Con­cen­tra­tion is even more ex­treme in the JSE top 40 in­dex, the most widely tracked in­dex.

Naspers and SABMiller weigh in at 11,5% and 11,3% re­spec­tively. In another in­dex pop­u­lar with track­ers, the share­holder-weighted top 40 (Swix), Naspers dom­i­nates at a stag­ger­ing 16% weight­ing.

War­ren Jervis, man­ager of Old Mu­tual Small Com­pa­nies Fund, of­fers a word of ad­vice.

“If you want to be in a pas­sive in­dex-track­ing eq­uity fund now you had bet­ter be well hedged,” says Jervis.

In a mar­ket with a rat­ing hov­er­ing around a 40-year high, there is ar­guably a strong case to be made for back­ing con­ser­va­tive ac­tive man­agers.

It does not need to be at the ex­pense of per­for­mance.

This is pretty clear from the per­for­mance of one of the most suc­cess­ful ac­tive man­agers, Jan Mou­ton, who has de­liv­ered re­peat­edly for his PSG Flex­i­ble Fund over the past 11 years.

“The fund’s port­fo­lio is at its most con­ser­va­tive ever,” says Mou­ton. “I have re­duced ex­po­sure to eq­uity to 60% [25% off­shore] and lifted cash to 40%.”

Not that Mou­ton could ever be ac­cused of be­ing gung ho. “Over the past 10 years cash has av­er­aged 25% of the fund’s hold­ings,” says Mou­ton.

This did not stop the fund from pro­duc­ing a solid per­for­mance, over the past three years to 30 June de­liv­er­ing a 75,6% re­turn. This was com­fort­ably ahead of the Alsi’s 68,6% re­turn.

Mou­ton achieved this with­out be­ing an in­dex hug­ger. “The fund is very dif­fer­ent to the top 40,” he says. “I have held nei­ther Naspers nor SABMiller.”

What have been driv­ing per­for­mance are the likes of EOH, Stein­hoff and Capitec in SA and off­shore, Berk­shire Hath­away, at a 6% weight­ing the fund’s largest hold­ing.

Berk­shire Hath­away de­liv­ered a re­turn of 72% in dol­lars over the past three years.

Over­all the fund’s eq­uity hold­ings have a value slant, with a

weighted av­er­age 11 price:earn­ings ra­tio com­pared with the top 40 in­dex’s 18 PE.

The slant to value is at a time when many value man­agers have been through a tor­rid three years. In­deed, so tor­rid that they have done a good selling job for tracker funds.

“The mar­ket has been mo­men­tum-driven,” says Nie­mand. He is re­fer­ring to the phe­nom­e­non of in­vestors chas­ing fast-ris­ing growth shares ir­re­spec­tive of their val­u­a­tions and ig­nor­ing lower-rated shares po­ten­tially of­fer­ing bet­ter value.

Re­flect­ing the mo­men­tum na­ture of the mar­ket are val­u­a­tions of top 40 in­dex high-flyer growth stocks Naspers (109 PE), Richemont (34 PE), Aspen (32 PE), SABMiller (29 PE) and Mr Price (29 PE).

Claude van Cuyck, co-man­ager of the SIM Value Fund, be­lieves the tip­ping point from mo­men­tum back to value may be close. “We are at the point in the cy­cle where value man­agers’ chances of out­per­form­ing are ex­cel­lent,” says van Cuyck.

“Where PEs are now, there is a good chance of them con­tract­ing. Value out­per­forms when PE val­u­a­tions are con­tract­ing, not ris­ing.”

A re­cent SIM study high­lights this. Across six pe­ri­ods of ris­ing PEs be­tween 1997 and the latest run, which be­gan in Septem­ber 2011, value as a style un­der­per­formed growth/ mo­men­tum in­vest­ing in all but one pe­riod. Over­all, value un­der­per­formed growth by an av­er­age of 26%. The cur­rent pe­riod of ris­ing PEs has seen value un­der­per­form by 69%.

The pic­ture is very dif­fer­ent in pe­ri­ods of fall­ing PE rat­ings. Across five of these since 1998 value out­per­formed growth by an av­er­age of 23%.

Van Cuyck and his co-man­ager Ricco Friedrich have not been put to shame over the past three years, SIM Value Fund turn­ing in a re­turn of 63%. Some­what be­low the Alsi’s re­turn, van Cuyck notes: “Al­pha [mar­ket out­per­for­mance] does not come in a straight line.”

The fund has de­liv­ered al­pha aplenty since its launch in 1998, turn­ing in an av­er­age 21,7%/year re­turn af­ter costs com­pared with the Alsi’s 18,25%/year.

Pow­ered by com­pound­ing, it adds up to to­tal out­per­for­mance of just un­der 1 100%.

Van Cuyck at­tributes out­per­for­mance in part to the fund’s mod­est size, of about R4bn in as­sets. “It gives us a spec­trum of op­por­tu­ni­ties across at least 120 shares,” he says. “Big funds of, say, R30bn are lim­ited to the top 40 or 50 shares.”

Evan Walker, co-man­ager of the R2bn-as­set 36One Eq­uity Fund, agrees. “When funds get too big and be­come an Alsi 40 proxy,” he says, “they are in the same po­si­tion as in­dex track­ing funds — a lot of con­cen­tra­tion risk, no flex­i­bil­ity and no ex­po­sure to small- and mid-caps.”

Walker stresses: “Our job is de­liv­er­ing al­pha.” His fund has done so in style, turn­ing in a 94% three-year re­turn — the best of any gen­eral eq­uity fund — and a 15,7% one-year re­turn.

Walker at­tributes the suc­cess in part to mid- and small-cap ex­po­sure, which is held at about 25%. “It’s where we pro­duce al­pha,” he says.

Also play­ing a big role is flex­i­bil­ity. As an ex­am­ple, he says, a 7% ex­po­sure to Sa­sol was sold at around R7/share at the first sign of the oil price’s slump in 2014. “We re­bought at around R4,” he says. Now at a 5% ex­po­sure to Sa­sol, he adds: “We can sell it in a day. A big fund could not do that.”

Funds such as 36One Eq­uity, PSG Flex­i­ble and SIM Value re­flect ac­tive as­set man­age­ment at its best. There are oth­ers, in­clud­ing Fo­ord Eq­uity, Mar­riott Div­i­dend Growth, Investec Eq­uity and, at a still man­age­able R7,8bn in as­sets, Coro­na­tion Eq­uity, that con­tinue to pro­duce con­sis­tent mar­ket-beat­ing re­turns.

An­drew Kemp, head of in­vest­ment prod­ucts at Lib­erty Cor­po­rate, says it’s a dis­pute that isn’t go­ing to be set­tled any­time soon.

“Sup­port­ers of pas­sive-style in­vest­ing point to the fact that pas­sive in­vest­ment styles have sig­nif­i­cantly lower costs than ac­tive man­agers and do not re­quire a high level of trustee gov­er­nance. Mean­while, those in the ac­tive cor­ner typ­i­cally ar­gue that, with spe­cialised man­age­ment, funds can de­liver higher-than-in­dex re­turns for in­vestors and pre­dict pos­si­ble mar­ket down­turns,” he says.

But Kemp says these ap­proaches need not be mu­tu­ally ex­clu­sive. Some funds, he says, use a com­bined ap­proach, and cites Lib­erty’s Sta­ble Growth Fund, which now has R7bn in as­sets un­der man­age­ment, as one ex­am­ple.

Kemp says this is done by us­ing a pre­dom­i­nantly pas­sive ap­proach to get ex­po­sure to mar­kets, while im­ple­ment­ing strate­gies to man­age risk all at a lower cost.

This sort of hy­brid ap­proach may be­come more pop­u­lar as the de­bate con­tin­ues to rage.

But to write ac­tive man­age­ment off would in­deed be more than a lit­tle pre­ma­ture.

Back­ing con­ser­va­tive ac­tive man­agers does not need to be at the ex­pense of per­for­mance

Pic­ture: THINKSTOCK

Pic­ture: HETTY ZANTMAN

Jan Mou­ton … Port­fo­lio at its most con­ser­va­tive.

Pic­ture: THINKSTOCK

Pic­ture: JEREMY GLYN

Evan Walker … Our job is de­liv­er­ing al­pha.

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