Active vs passive investment: The better strategy
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.