Ac­tive vs pas­sive in­vest­ment: The bet­ter strat­egy

Finweek English Edition - - INSIDE - BY SCHALK LOUW

Mankind has al­ways been search­ing for ways to beat the ‘sys­tem’. Through the cen­turies, peo­ple have proven that they are not afraid to take risks – whether sail­ing into the vast­ness of the ocean in search of new con­ti­nents or set­ting up a for­mula to de­ter­mine the win­ning lotto num­bers.

Peo­ple gen­er­ally pre­fer to t ake ac­tion and con­sider pas­sive be­hav­iour to be i nfe­rior. Ac­tive man­age­ment in the in­vest­ment world refers to a strateg y whereby i nvestors make de­lib­er­ate de­ci­sions with the aim of achiev­ing spe­cific out­comes, such as out­per­form­ing cer­tain share in­dices.

Pas­sive man­age­ment on the other hand, means that in­vestors make very few changes to their port­fo­lios and usu­ally man­age to keep their costs rel­a­tively low as a re­sult.

The gen­eral per­cep­tion is that ac­tive man­age­ment should be a bet­ter strat­egy, but over the past few years in­vestors have paid a lot more at­ten­tion to pas­sive man­age­ment. South Africa is no ex­cep­tion.

Let’s look at the growth of the more ac­tive lo­cal gen­eral eq­uity unit trusts ver­sus t he more pas­sive ex­change traded funds (ETFs).

ETFs are highly trad­able col­lec­tive i nvest­ment schemes, l i sted on t he stock ex­change with the sole pur­pose of ren­der­ing 100% of the re­turns of a spe­cific in­dex, such as the JSE/ FTSE All Share In­dex. ETFs work in much the same way as unit trust in­vest­ments. This means that by buy­ing one ‘unit’, the in­vestor will gain ex­po­sure to a wide va­ri­ety of in­vest­ments. Some of the ad­van­tages this type of in­vest­ment of­fers us are:

■ In­vestors are well di­ver­si­fied over a va­ri­ety of shares, com­modi­ties, bonds, prop­erty shares and even off­shore in­vest­ments by merely in­vest­ing in one or two funds.

■ Costs are con­sid­er­ably lower. The to­tal ex­pense ra­tio ( TER) of stock ETFs was 0.65% over t he past 12 months; a mere 42% of the TER of the SA gen­eral eq­uity sec­tor, with an av­er­age TER of 1.55% over the same pe­riod.

■ ETFs are listed on the JSE, mak­ing them eas­ily trad­able and of­fer­ing the ben­e­fit of in­vest­ment liq­uid­ity.

■ ETFs are trans­par­ent, as in­vestors know ex­actly what they are in­vested in at all times.

Although both ac­tive and pas­sive in­vest­ments of­fer their re­spec­tive pros and cons, the ques­tion re­mains: which strat­egy is best?

Fund man­agers who man­aged to out­per­form the FTSE/ JSE All Share In­dex over the past 12 months have done so quite hand­somely (av­er­age out per f or mance of > 4%). But it be­comes very in­ter­est­ing when we take a closer look.

Out of the 132 eq­uity funds, only 55 suc­ceeded in out­per­form­ing the FTSE/ JSE All Share In­dex over the past 12 months. Even more in­ter­est­ing is that if you add up the unit trust TERs of all SA gen­eral eq­uity sec­tor f unds, in­vestors paid a whop­ping R4bn to as­set man­agers in this 12-month pe­riod – and only 42% of them man­aged to out­per­form the FTSE/ JSE All Share In­dex.

Eu­gene F Fama and Mer­ton H Miller in 1972 de­vised a the­ory based on f in­d­ing a tech­nique to beat the mar­ket con­sis­tently. Their find­ings proved t hat such a tech­nique was im­pos­si­ble in the long run. In­vestors can gen­er­ate ex­cep­tional re­turns over the short term, but this needs to be bal­anced over a longer term.

Sim­i­larly, Werner F M De Bondt and Richard Thaler found that fund man­agers who man­aged to gen­er­ate ex­cep­tional re­turns over a three- to fiveyear pe­riod, had trou­ble main­tain­ing this in the fol­low­ing years.

The mes­sage, i n shor t , i s t hat ETFs a re cheaper, but t hat good di­ver­si­fi­ca­tion re­mains the key to any suc­cess­ful port­fo­lio.

SOURCE: FE

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