Finweek English Edition - - FRONT PAGE - By Mariam Isa


bat­tle- scarred in­vestors are buoyed by prospects that global stock mar­kets will de­liver bet­ter re­turns this year de­spite con­tin­ued po­lit­i­cal and pol­icy un­cer­tainty in the US, Europe and Bri­tain and lin­ger­ing doubts over China’s eco­nomic slow­down.

The breath­tak­ing rally in US equities fol­low­ing the un­ex­pected elec­tion of Pres­i­dent Don­ald Trump in Novem­ber has had rip­ple ef­fects around the world and the pre­vail­ing view is that prospects are good for im­proved eco­nomic growth in many de­vel­oped and emerg­ing mar­kets.

US in­vestor sen­ti­ment has not been this pos­i­tive since 1987, and global stocks mea­sured by the MSCI World In­dex have hit a 19-month peak, while emerg­ing mar­kets are ex­pected to put in a strong per­for­mance de­spite suc­ces­sive hikes in US in­ter­est rates.

Ap­petite for risk is firmly back on the ta­ble, and South African stocks are in­cluded on the menu – at least for up­beat fund man­agers will­ing to look through jit­ters past the ANC lead­er­ship elec­tion in De­cem­ber and fo­cus in­stead on ex­pec­ta­tions for faster growth, lower in­fla­tion, and in­ter­est rate cuts in the sec­ond half of the year. The JSE closed 0.8% lower last year.

“We are more op­ti­mistic on risk as­set re­turns in 2017 […] The po­lit­i­cal back­drop in SA is still very murky, but it seems like things will be less volatile than last year,” says Rhyn­hardt Roodt, a fund man­ager at In­vestec As­set Man­age­ment.

“What is clear is that there is a broad-based cycli­cal re­cov­ery un­der­way, not just in the US. There’s quite a change in mar­ket lead­er­ship – in­dus­trial com­pa­nies tied to the real econ­omy are tak­ing over. It’s time to make money rather than pre­serve money.”

Roodt none­the­less doesn’t like the US mar­ket – he thinks it’s too ex­pen­sive. In SA, he thinks that the back­ground for lo­cal con­sumers and man­u­fac­tur­ers in par­tic­u­lar has im­proved and com­pa­nies like pack­aged goods and food man­u­fac­turer Tiger Brands, along with agripro­cess­ing and prop­erty gi­ant Ton­gaat Hulett, will do well. “The glory days of SA re­tail are over but peo­ple are un­der­es­ti­mat­ing the cycli­cal re­cov­ery.”

Mov­ing in­vest­ments off­shore

Fund man­agers are unan­i­mous in the view that now is a good time to move money off­shore, af­ter im­pres­sive gains in the rand, which ap­pre­ci­ated by 12.5% against the dol­lar last year and ex­tended its rally so far this year, touch­ing an 18-month peak at R12.80 to the dol­lar af­ter the Na­tional Bud­get last month.

An­a­lysts be­lieve that al­though the rand may ap­pre­ci­ate more in the short term, its cur­rent level is “fair value”, and in the long term fur­ther de­pre­ci­a­tion is in­evitable. Rec­om­men­da­tions vary, but fi­nan­cial plan­ners rec­om­mend that in­vestors keep at least 30% of their bal­ance sheet off­shore.

But bas­ing in­vest­ment de­ci­sions on ex­pec­ta­tions of a strong re­cov­ery in the US econ­omy and else­where may be mis­placed, as the suc­cess of Trump’s progrowth poli­cies are not guar­an­teed, warns Tim Buck­ley, chief in­vest­ment of­fi­cer at Van­guard. His com­pany was the best­selling global fund man­ager last year with nearly $200bn of in­flows from clients and more than $4tr in as­sets un­der man­age­ment.

One of the main rea­sons for Van­guard’s im­pres­sive per­for­mance is that it is owned by clients rather than share­hold­ers, who have a vested in­ter­est and are will­ing to ag­gres­sively pur­sue a low-cost sales strat­egy. But more im­por­tantly, the fund man­ager has also em­braced the con­tem­po­rary blue­print of in­cor­po­rat­ing both ac­tive and pas­sive busi­ness, rather than stick­ing stub­bornly to the old-school prac­tice of of­fer­ing the ser­vices of fi­nan­cial pro­fes­sion­als who scru­ti­nise com­pa­nies on a daily ba­sis – charg­ing high fees for in­vestors.

Ac­tive ver­sus pas­sive funds

Faith in ac­tive fund man­agers has waned dra­mat­i­cally in the past few years, on mount­ing ev­i­dence that very few man­age to out­per­form funds that are linked to the per­for­mance of a broad stock in­dex. A stag­ger­ing three-quar­ters of South African eq­uity funds un­der­per­formed the S&P South African Do­mes­tic Share­holder Weighted In­dex over five years. On top of that there is a mas­sive, though nar­row­ing, gap in the costs of both types of in­vest­ments – the av­er­age ex­pense ra­tio for an ac­tively man­aged eq­uity fund was 1.4% last year, while the av­er­age ex­pense ra­tio for a pas­sive

“There’s quite a change in mar­ket lead­er­ship – in­dus­trial com­pa­nies tied to the real econ­omy are tak­ing over. It’s time to make money rather than pre­serve money.”

eq­uity fund was 0.6%, ac­cord­ing to Thom­son Reuters Lip­per. Other es­ti­mates are lower – global in­vest­ment re­searcher Morn­ingstar puts av­er­age ac­tive fees at 0.78% and av­er­age pas­sive fees at 0.18%.

In­vestors have voted with their feet and piled into pas­sive in­vest­ments – which have grown by 230% glob­ally since 2007 to $6tr, ac­cord­ing to Morn­ingstar. This was four times the growth rate of as­sets held in ac­tive funds, which are still dom­i­nant.

The other anom­aly is that over time, low-cost ac­tively run funds have a much greater chance of beat­ing bench­mark in­dices than their more ex­pen­sive peers, and also sur­vive longer than the high­est-cost funds.

Fund man­agers in­sist that dur­ing a time of low re­turns and high volatil­ity, in­vest­ing with man­agers that have a demon­stra­ble track record of suc­cess­ful as­set al­lo­ca­tion will be­come even more im­por­tant.

They do have a case – re­search has shown that low-cost ac­tively man­aged funds in mid­cap and small-cap value, along with emerg­ing mar­kets (EM) – have a bet­ter suc­cess rate against pas­sive peers.

Ac­cord­ing to Morn­ingstar, close to two-thirds of ac­tive di­ver­si­fied EM funds out­per­formed their pas­sive coun­ter­parts over the one- and three­year pe­ri­ods which ended on 30 June 2016, while just over 55% per­formed over five years. In the longer term less than one-third of those funds out­per­formed – but while 60% of the low­est­cost ac­tively man­aged di­ver­si­fied EM funds out­per­formed their in­dex fund coun­ter­parts over the 10-year pe­riod, less than 12% of the high­est­cost funds in that cat­e­gory did.

In­vestors of all risk pro­files with in­vest­ment hori­zons of 10 years or more stand a bet­ter chance of meet­ing their in­vest­ment ob­jec­tives merely by re­duc­ing the fees that they pay.

“Fees mat­ter – they are one of the only re­li­able pre­dic­tors of suc­cess,” the Morn­ingstar re­port said.

A blended ap­proach

The shift to us­ing a mix of pas­sive and ac­tive funds is well un­der way in the US, but many South African re­tail in­vestors con­tinue to in­vest in ac­tively man­aged bal­anced funds of­fered by lo­cal unit trust com­pa­nies.

San­lam, Ned­group In­vest­ments and Old Mu­tual are among the as­set man­agers that have started to use a blend of pas­sive and ac­tively man­aged funds, and a hand­ful of fi­nan­cial ad­vis­ers are con­struct­ing port­fo­lios in step with the trend.

“We do not be­lieve that this is an ar­gu­ment which peo­ple need to take sides on,” says Craig Gra­didge, a fi­nan­cial plan­ner and founder at Gra­didge-Mahura In­vest­ments. “We have been do­ing it since 2009.”

Ac­cord­ing to a sur­vey last year by E-trade Fi­nan­cial Cor­po­ra­tion, about 60% of ex­pe­ri­enced in­vestors in the US say they pre­fer port­fo­lios that com­bine pas­sive and ac­tive man­age­ment, with a pas­sive ap­proach in broad mar­ket ar­eas and ac­tive man­age­ment in nar­rower, less ef­fi­cient mar­ket seg­ments.

About 30% favour a purely pas­sive ap­proach while just 8% pre­ferred a com­pletely ac­tive one.

And a grow­ing num­ber of savvy funds and fi­nan­cial man­agers has be­gun to fol­low Van­guard’s lead of blend­ing pas­sive in­vest­ing, ac­tive in­vest­ing, and “smart beta” in­vest­ing – which means us­ing strat­egy in­dices con­structed to earn re­turns from dif­fer­ent types of “fac­tor” risk – growth, mo­men­tum, value, or volatil­ity. Around $500bn has been in­vested in “smart beta” strate­gies glob­ally, up from just $50bn five years ago. (Also see page 16.)

“We be­lieve there is space for pas­sive in­vest­ing, smart beta, and fun­da­men­tal ac­tive in­vest­ing,” Old Mu­tual In­vest­ment Group said in a re­search note on the 2017 in­vest­ment out­look.

“A blended com­bi­na­tion of these three ap­proaches should de­liver the best riskad­justed re­turns for clients.”

Blend­ing not only of­fers lower costs, but cre­ates greater cer­tainty of out­come by re­duc­ing re­liance on ac­tive man­agers de­liv­er­ing on their ob­jec­tives, while al­low­ing for al­lo­ca­tions to “higher con­vic­tion” fun­da­men­tal man­agers, it added.

Van­guard rec­om­mends build­ing a core port­fo­lio of in­dex-track­ing funds while adding care­fully se­lected ac­tively man­aged satel­lite funds or spe­cial­ist in­dex funds, which can com­ple­ment the core and pro­vide the po­ten­tial for higher re­turns.

Adding tech­nol­ogy to the mix

Black­rock, the world’s largest as­set man­ager, has a dif­fer­ent ap­proach. It sug­gests that

About 60% of ex­pe­ri­enced in­vestors in the US say they pre­fer port­fo­lios that com­bine pas­sive and ac­tive man­age­ment.

in­vestors should think of ac­tive funds as long-term, core hold­ings and look for those with “broad man­dates” and as­set classes that are dif­fi­cult to rep­re­sent with an in­dex.

Pas­sive funds should be con­sid­ered to achieve pre­cise, tac­ti­cal ex­po­sure to cer­tain as­set classes in a cost-ef­fec­tive and tax-ef­fi­cient man­ner, it says. Rather than switch­ing from one style to an­other as mar­ket or eco­nomic con­di­tions change, adopt­ing a long-term, strate­gic frame­work blend­ing ac­tive and pas­sive as­sets is more pro­duc­tive, it ad­vises.

“I think ev­ery­one will have an in­di­vid­ual ap­proach based on their dif­fer­ent lev­els of in­vest­ment and ed­u­ca­tion, but blended strate­gies work quite well,” says Mark Lind­heim, chief in­vest­ment of­fi­cer for In­vest­ment So­lu­tions.

A new type of de­vel­op­ment man­ager for the beta ap­proach is evolv­ing, who would use math­e­mat­i­cal mod­el­ling on com­put­ers to sift through a large amount of data to con­struct port­fo­lios, as op­posed to more tra­di­tional stock-pick­ing, Lind­heim notes.

But he adds that tech­nol­ogy could not yet match hu­man abil­ity to fol­low the psy­chol­ogy of mar­ket be­hav­iour, and fac­tor in sen­ti­ment and per­cep­tions which were not driven by fun­da­men­tals.

“The best ap­proach is to blend large data-crunch­ing and over­lay it with hu­man in­ter­ven­tion – we are mov­ing to an age where there are more tech­nol­ogy-based in­vest­ment de­ci­sions.”

What this means is that fi­nan­cial ad­vis­ers are start­ing to work side-by­side with ma­chines, as they al­ready do in man­u­fac­tur­ing and ser­vice in­dus­tries.

“So­lu­tions is the buzz­word – peo­ple don’t want a prod­uct, they want to solve a prob­lem. There is less chance of do­ing that with one tool than with many,” he says.

Which ETFs look at­trac­tive?

The boom­ing global ap­petite for ex­change-traded funds (ETFs), which are sim­i­lar to other in­dex­track­ing funds but are traded through­out the day like a share, has been re­flected on the JSE. About 80 are now listed on the bourse. Ne­rina Visser, strate­gist at et­fSA, says she is still in favour of rand hedge in­vest­ments with less ex­po­sure to South Africa, be­cause of the coun­try’s poor growth out­look and po­lit­i­cal un­cer­tainty. Fig­ures re­leased on 7 March showed that the econ­omy con­tracted in the fourth quar­ter of last year, in­di­cat­ing that growth slowed to 0.3% in 2016 – the slow­est pace since the re­ces­sion in 2009. This means that fore­casts for this year are likely to fall be­low ex­pec­ta­tions, and credit rat­ing down­grades to junk sta­tus later in 2017 are in­evitable, which will put pres­sure on the rand. Visser’s ETF picks for the year in­clude the Sa­trix Indi 25, an ETF with a 70% ex­po­sure to mar­kets out­side of SA, which has clocked up an­nual av­er­age growth in re­turns of about 16% over the past 10 years. The big­gest weight­ing within the fund is global in­ter­net and en­ter­tain­ment group Naspers* – also rec­om­mended by tra­di­tional stock­pick­ers, largely due to its 34% hold­ing in Ten­cent, a lead­ing provider of in­ter­net value-added ser­vices in China. Visser also favours Deutsche Bank’s MSCI China Ex­change Traded Note, which has re­turned an av­er­age of 15.37% over each of the past five years. Visser ex­plains that her pos­i­tive view on the Chi­nese en­vi­ron­ment is not based on the coun­try’s growth out­look, but be­cause it is loos­en­ing up its re­stric­tions to for­eign in­vestors and its rep­re­sen­ta­tion on global eq­uity in­dices and port­fo­lios is well be­hind its eco­nomic mus­cle. The Core Shares S&P Top 50 is an­other ETF that Visser ex­pects to do well be­cause of its sta­tus as a di­rect US in­vest­ment.

Swim­ming against the stream

Back in the world of tra­di­tional in­vest­ing, Adrian Sav­ille, chief strate­gist at Ci­tadel, has some­what con­trar­ian views.

He rec­om­mends that lo­cal in­vestors fo­cus more on mid- and small-cap com­pa­nies, which he be­lieves are rel­a­tively un­der-re­searched and un­known in SA de­spite the fact that many are well-run and have strong bal­ance sheets. ed­i­to­rial@fin­week.co.za

Rhyn­hardt Roodt Fund man­ager at In­vestec As­set Man­age­ment

Craig Gra­didge Founder of Gra­didgeMahura In­vest­ments

Tim Buck­ley Chief in­vest­ment of­fi­cer at Van­guard

Ne­rina Visser Strate­gist at et­fSA

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