Financial Mail - Investors Monthly
BEST OF BOTH
Index tracking and active investment each has its place, writes Johann Barnard
Index tracking and active investment each has its place
O nce a year, fund managers get to see how they have measured up against what the market returned over the previous 12 months.
This exercise is not much different from a school report card in which you see how you scored compared with your classmates. However, the stakes for fund managers are much higher.
They’re not lining up in front of the headmaster or teacher, but in front of a far more discerning bunch: the investors whose money they’re tasked with protecting and growing.
While results always differ according to what has happened in markets, economies and industry sectors, there is an emerging trend that is less than flattering for active investment managers. According to the annual S&P Indices Versus Active (Spiva) scorecard, the vast majority of active fund managers have produced lower returns than their respective benchmark indices.
The scorecard for SA managers in the year to the end of 2016 continues this tendency.
For that 12-month period, more than 72% of active managers of SA’s general equity funds underperformed the index. That number grows to more than 76% for fund managers in the global equities space, while it is nearly 83% for those in diversified bonds.
It would be easy to dismiss this as being related to the unexpected events last year, when resources recovered, the rand strengthened and global certainty was rocked by the election in the US and the Brexit poll.
However, unfortunately the comparison of returns over three and five years further highlight the challenge active fund managers face. Over three years, 80% of SA equity fund managers were below the index, and over five years that number is 77%. Managers in global equities suffered even greater setbacks, with 96% underperforming over three years and 93% over five.
Does this mean that investors are being sold short by their fund managers?
No, not willingly. But it does illustrate that producing superior returns is far from simple and that active managers’ skills are being put to the test severely. Those skills are not only their stock-picking abilities or choice of investment strategy, but also their fortitude and commitment to a longterm investment horizon.
It is important to note that
Institutional clients appreciate the systematic nature of these products, and the transparency around them
underperforming an index is not an indicator of negative returns. Active managers may still be able to deliver growth, but at a rate below that produced by an index.
According to data from the Spiva scorecard, the difference between the average performance of actively managed funds and the index is seldom more than two or three percentage points. Achieving that average performance, however, does mean that some funds deliver negative returns.
Leon Campher, CEO of the Association for Savings & Investment SA, cautions investors that index tracking funds are by no means a guarantee against loss.
“One must understand that if you’re in a tracker fund that mirrors the all-share index and something happens that makes the market decline by 20%, your fund is going to decline by 20%,” he says. “Tracker funds are therefore not defensive instruments. If you want to be defensive you must spread your investment across different asset classes.”
In SA, only about 2.4% (R55bn) of the country’s R2 trillion in collective investments are invested in passive or index funds at present. Compare this with the US, where the exchange traded fund (ETF) market alone has attracted US$2.7 trillion in assets, with more than $160bn of inflows in the year to end-April, according to Bloomberg.
“We are following international trends because the tracker industry is growing, though it is still in its infancy compared with overseas,” Campher says. “We suspect it will be a growing part of our industry. But I think the debate around active versus passive investment has been quite infantile. It’s not about one or the other. In any well-balanced portfolio there should be place for a passive fund together with an active fund and maybe even a hedge fund.
“The debate should be about what is right for the client and in what proportion it is suitable for the client’s needs.”
Campher points out that the good active managers in SA have shown it is possible to outperform the market — and they have managed to do so consistently. Given the comparatively small and concentrated nature of the SA market, he says, the ability to outperform is sometimes as much a function of stocks left out of a portfolio as it is of what is contained in it.
It is no surprise that the growing interest in inactive investment solutions has led to the emergence of investment managers that specialise in index-tracking products.
CoreShares is one example of such a business built around growing investor appetite. MD Gareth Stobie says the company has experienced consistent growth since its first ETF was launched in 2012, and especially since the reformation of the brand following strategic investments by the likes of Rand Merchant Investments.
“The awareness about passive and index funds and costs has never been better,” he says. “The education the market was crying out for three to four years ago is now starting to sink in. Passive investment is slowly but surely grinding away at the active managers’ market share, but we’re not there yet. One of the dilemmas we have to overcome in SA is the narrative set by the active houses that passive investing is something that works in the US, but is less relevant in SA. If you look at the results of the Spiva report, the same dynamics play out in our market as in other global markets.”
With the near-98% dominance of money in active funds, there is still a long way ahead for proponents of passive investing. What will go some way towards accelerating them along that journey is the creation of unique ways to track indices or sub sets within indices. Smart beta funds, for instance, allow managers to apply rules that might favour dividends, momentum or even volatility over the traditional cap-weighted index strategy.
SA’s oldest provider of index tracking funds, Satrix, is introducing exactly these kinds of investment in response to market demands. That demand, for retail investors, includes clients looking for specific asset classes in passive vehicles or multiasset vehicles that are actively managed.
Satrix head of portfolio solutions Jason Swartz says indextracking funds are especially popular with institutional clients who are more risk averse and willing to invest for the long term.
“Institutional clients appreciate the systematic nature of these products, and also the transparency around them. These products, in a sense, offer [what] active managers do, but they’re implemented in a rules-based way.
“And that appeals to institutional clients who are looking for a targeted strategy.”
He adds that while interest in the smart beta-type funds is slowly gaining traction, this is sure to accelerate in future.
And it’s a compelling case when the index trackers are consistently beating the active managers. But as managers of both active and passive funds point out, the decision is not a matter one over the other but rather how they both fit into your portfolio.
It is no surprise that the growing interest in inactive investment solutions has led to the emergence of investment managers that specialise in index-tracking products