Passive solutions: More tools in the investing toolbox BY BERNARD FICK
ICEO of Prudential Investment Managers nde x t r a c k i ng or “pa s s i v e ” i n v e s t ment s h a v e b e c o me increasingly popular in the US and other developed markets over the past decade and are also gaining ground in South Africa.
According to global i nvestment group BlackRock, approximately 25% of all US assets under management are now managed passively, compared to 13% in 2004, while in Europe about 11% is passively managed as opposed to only 4% a decade ago.
In South Africa, while the exact number is not known, the f igure is much lower – approximately R124bn is invested in exchange-traded funds (ETFs), most of which track indices, compared to over R1.7tr in unit trusts
that are mainly actively managed.
CEO OF PRUDENTIAL INVESTMENT MANAGERS Index tracking funds aim to produce returns that are in line with the average return of a market index, such as the FTSE/JSE All Share Index (Alsi). They simply buy all of the underlying shares in the index according to the index weighting, and use automated trading programmes to regularly re-weight the portfolio, reflecting the price movements of the shares over time. It is important to point out that actual investor returns in an index tracker must, by definition, be lower than the index returns due to trading and administrative costs, plus management fees. Tracking error also plays a role. If a passive fund tracks an index based on market capitalisation, it buys more exposure to t he l argest and most expensive companies in the index as prices rise, and sells as prices fall. This approach is considered fundamentally f lawed by valuation-based investors like Prudential, which focus on buying those companies offering the best value.
Passive product providers have c onsequent l y de v e l oped a wide variety of funds that can track more sophisticated benchmarks. These are often described as “smart beta” or “enhanced indexation” products, since they aim to provide a way of beating the market capitalisation index.