Though there is mount­ing con­cern about the growth of ETFs as a tool of pas­sive trad­ing, ac­tive fund man­agers still have an im­por­tant role to play, writes Jo­hann Barnard

Financial Mail - Investors Monthly - - Contents -

Don’t panic about pas­sives

A ny­one fol­low­ing in­vest­ment mar­kets will have be­come aware of the grow­ing promi­nence of the pas­sive in­vest­ment phi­los­o­phy, specif­i­cally through in­dex track­ing funds. The rise of ex­change traded funds (ETFs) as the flag­bearer for in­dex track­ing as a strat­egy will surely have ap­peared on the radar of even the most de­tached in­vestor.

This grow­ing aware­ness would have been stirred by the in­dus­try’s mar­ket­ing ef­forts, as well as the grow­ing choice of pas­sive prod­ucts.

In SA those num­bers are still a frac­tion of the over­all mar­ket, mak­ing up less than 2.5% of as­sets held by the col­lec­tive in­vest­ments in­dus­try.

Glob­ally, the fig­ures are rather dif­fer­ent, with one pro­jec­tion be­ing that the value of US pas­sive in­vest­ments will reach par­ity with ac­tive money by 2020.

Given this rate of growth, what is the fu­ture for ac­tive man­agers? And if this growth con­tin­ues un­abated, what are the im­pli­ca­tions for mar­kets and in­vest­ment fun­da­men­tals as we’ve known them?

“I do be­lieve this is a global mega-trend,” says Kings­ley Wil­liams, chief in­vest­ment of­fi­cer of in­dex­a­tion ca­pa­bil­ity at Old Mu­tual Cus­tomised Solutions. “The largest funds in the US now are in­dex funds, and we’re see­ing mar­kets like Europe and UK fol­low the US’s lead.

“SA is a very so­phis­ti­cated and de­vel­oped fi­nan­cial mar- ket, so it’s hardly sur­pris­ing to see that trend play out here. And I don’t think it’s a short­term thing — I see it as a longterm mega-theme.”

But what of the im­pact on the mar­ket, should adop­tion rates con­tinue?

Ja­son Swartz, head of port­fo­lio solutions at Sa­trix, says this is a ques­tion the pas­sive in­vest­ing in­dus­try hears of­ten.

“I don’t think pas­sive is go­ing to take over all the as­sets,” he says. “There will al­ways be a propo­si­tion for ac­tive man­agers and those who be­lieve they can out­per­form the mar­ket. So, they will al­ways at­tract as­sets.

“And it def­i­nitely won’t

cause any dis­rup­tion to mar­ket ef­fi­ciency. There will al­ways be ac­tive as­set man­agers to bal­ance that. We think there is a role for both. It could be that pas­sive takes up more of that space but I don’t think it’s go­ing to cause huge dis­lo­ca­tions.”

Con­cerns around the pos­si­bil­ity for mar­ket dis­tor­tions or dis­rup­tion were raised again in April by FPA Cap­i­tal Fund, when it said in a note to clients that ETFs are “weapons of mass de­struc­tion” that have dis­torted stock prices.

“When the world de­cides there is no need for fun­da­men­tal re­search and in­vestors can just blindly pur­chase in­dex funds and ETFs without any re­gard to val­u­a­tion, we say the time to be fear­ful is now,” the ac­tive fund man­ager said.

Fears such as these are based largely on the in­dus­try en­ter­ing un­fa­mil­iar ter­ri­tory and pos­si­bly a lit­tle games­man­ship by an ac­tive man­ager, hop­ing to un­set­tle in­vestors who have ev­ery rea­son to be seek­ing a safer port for their money.

The pur­suit of less risky in­vest­ment op­tions is also ev­i­dent in SA, with more than 50% of as­sets in col­lec­tive in­vest­ments now sit­ting in mul­ti­as­set port­fo­lios.

Fig­ures from the As­so­ci­a­tion for Sav­ings & In­vest­ment SA for the 2016 cal­en­dar year show that 51% of as­sets are held in SA mul­ti­as­set port­fo­lios, 24% in equity port­fo­lios, 16% in money mar­ket port­fo­lios and 9% in other in­ter­est-bear­ing port­fo­lios.

Last year, mul­ti­as­set port­fo­lios at­tracted R71bn, dwarf­ing the R10bn that flowed into equity-only port­fo­lios.

It is not sur­pris­ing, there­fore, that the in­dex-track­ing in­dus­try has re­sponded by devel­op­ing funds that ac­com­mo­date de­mand for a more de­fen­sive po­si­tion. A pas­sive fund, af­ter all, is only de­fen­sive if the in­dex be­ing tracked is a lower-risk one com­pared with the rest of the mar­ket.

If the value of an in­dex falls, so does the value of the in­dex tracker.

Wil­liams points out that the re­sponse to a lower risk ap­petite is ev­i­dent in prod­ucts such as his re­cently launched con­ser­va­tive, mul­ti­as­set in­dex tracker.

“This fund is down-weight­ing eq­ui­ties and giv­ing you more ex­po­sure to more de­fen­sive as­set classes like bonds, in­fla­tion-linked bonds and cash,” he says.

“One of the big­gest mis­takes that in­vestors can make is to be too con­cerned about short­term moves be­cause the longer you re­main in­vested the bet­ter chance you give your­self of grow­ing and pro­tect­ing your wealth. And time is the big­gest card you have up your sleeve in terms of achiev­ing your in­vest­ment ob­jec­tives.”

Core­Shares MD Gareth Sto­bie says this type of evo­lu­tion and in­no­va­tion around in­vestors’ needs is an­other rea­son mar­kets are un­likely to be top­pled by un­hin­dered growth in pas­sive funds.

“Smart beta in­dices, for ex­am­ple, are de­signed specif­i­cally to act more like ac­tive man­agers than pas­sive man­agers. By de­sign they’re not linked to mar­ket cap, so they bring in a dif­fer­ent dy­namic that would chal­lenge the thought that pas­sive would run away with things,” he says.

He says there may be rea­son for con­cern if 90% of the mar­ket were pas­sive and 10% ac­tive, but adds that we’re still a long way from that point.

The pos­si­bil­ity of reach­ing such pro­por­tions is, nat­u­rally, doubt­ful.

In­dus­try par­tic­i­pants point out that the fun­da­men­tals of the mar­ket dic­tate that a dis­pro­por­tion­ate bias in one di­rec­tion will cre­ate an op­por­tu­nity on the op­po­site side. So, in the un­likely event that pas­sive funds achieve mar­ket-dis­tort­ing dom­i­nance, this could just as eas­ily bring ac­tive man­agers’ strat­egy back into play.

Sto­bie ar­gues that any number of cat­a­strophic mar­ket or eco­nomic events could swing back in favour of ac­tive man­agers.

Even S&P Dow Jones In­dices, the MacDaddy of in­dex in­vest­ing, is not con­vinced of the prospect of pas­sive in­vest­ment dom­i­nat­ing mar­kets.

“There is so much money still be­ing man­aged ac­tively that it’s go­ing to take years for pas­sive to dom­i­nate. So I don’t think it’s a con­cern at all at this stage,” says Zack Bezuiden­houdt, head of S&P Dow Jones In­dices for SA and sub-Sa­ha­ran Africa. “If too many are track­ing the in­dex, then fund man­agers might say they could now out­per­form the bench­marks.”

He adds that, should pas­sive man­age­ment grow to dom­i­nate as un­der­per­form­ing ac­tive man­agers make the switch to in­dex track­ing, the re­main­ing ac­tive man­agers may ac­tu­ally achieve higher re­sults in S&P’s an­nual re­port card.

Ac­cord­ing to the lat­est S&P In­dices Ver­sus Ac­tive score­card, 72% of ac­tive man­agers of SA gen­eral equity funds un­der­per­formed the in­dex in the past year. This un­der­per­for­mance is nei­ther cycli­cal — long-term re­sults pro­duce the same out­come — nor en­demic to SA.

This is surely one of the rea­sons for the phe­nom­e­nal growth in pas­sive fund in­flows.

For now, how­ever, and prob­a­bly for many years yet, in­vestors need not worry about mar­ket dis­tor­tions due to the pop­u­lar­ity of in­dex track­ers.

If his­tory has any les­son to teach us it’s that things will change, and we will adapt ac­cord­ingly.

That adap­ta­tion does not, at this stage, de­mand a re­think of mar­ket and in­vest­ment fun­da­men­tals. Mar­kets have, af­ter all, tended to bal­ance them­selves out through es­tab­lished prin­ci­ples like sup­ply and de­mand. The same forces are ex­pected to keep the pas­sive and ac­tive mar­kets in check, even once the value of pas­sive in­vest­ments reach par­ity with ac­tive ones.

In­dus­try par­tic­i­pants point out that the fun­da­men­tals of the mar­ket dic­tate that a dis­pro­por­tion­ate bias in one di­rec­tion will cre­ate an op­por­tu­nity on the op­po­site side

Kings­ley Wil­liams

Ja­son Swartz … there will al­ways be a propo­si­tion for ac­tive man­agers and those who be­lieve they can out­per­form the mar­ket

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