Active-passive debate ‘ignores your needs’
investment term, you are guaranteed to come out with 65 percent more than someone who paid twice as much in fees and lost one percent a year by switching, everything else being equal.
When it comes to your optimal exposure to equities, the gains you can make are less certain.
However, Jensen says testing based on past market returns of the JSE shows that, in various market conditions since 1900, if you had 75 percent of your portfolio in equities, rather than 60 percent, on average you would have 75 percent more savings at retirement.
This shows it is more likely that you will earn a higher return in a high-equity portfolio than you would have earned in a lower-equity portfolio (see graph, right).
To obtain exposure to equities of 75 percent and fees lower than one percent a year, 10X advocates the use of lower-cost index-tracking investments.
YOU GET WHAT YOU PAY FOR
Active managers, however, argue that paying more in fees for active portfolio management can, potentially, deliver a higher return.
Personal Finance asked top active managers Allan Gray, Foord and Investec Asset Management for their view on 10X’s “three big wins”.
Sangeeth Sewnath, the deputy managing director of Investec Asset Management, says the principles encouraged by 10X are good, but if you followed them in a “blinkered manner”, they might not necessarily lead to the best outcome for you, the investor.
“First, we believe that using a financial adviser adds significant value in ensuring a client invests in the correct investments given their risk appetite and time horizon. Financial advisers are also critical in ensuring that clients stay the course when markets are as volatile as we have seen recently,” Sewnath says.
Investec does not believe that a static or unchanging allocation to different asset classes is necessarily beneficial, he says, and cites the Investec Opportunity Fund as an example of an actively managed fund that has out-performed the FTSE/JSE All Share Index, achieving an average annualised return of 16.1 percent over the past 19 years.
“By virtue of the above, we also don’t believe that passive investing is the correct decision. We are proudly active managers,” he says. On the issue of fees, Sewnath says that what you pay is an important consideration, but it’s relative to the returns you get. “If a manager has shown that over the long term it can add value – say, two to three percent more than the index – by allocating to different stocks, asset classes and offshore, is it not worth paying 20 to 30 basis points more?
“As 10X points out, a one-percent differential in fees has a meaningful impact on your value, but so does one percent in performance,” Sewnath says.
The total expense ratio (TER) of a fund tells you what you pay in fees and other costs each year as a percentage of your investment, and the TERs of actively managed funds range between about one and 3.5 percent a year.
Richard Carter, the head of product development at Allan Gray, says it’s very important not to over-pay, because high fees erode returns. If you are paying higher-than-average fees, you need to be sure that you are getting the returns for those fees, he says.
Paul Cluer, the managing director of Foord, says “premium” investment managers – those with long and established track records, good and replicable investment processes and high prospects of delivering inflation-beating returns into The uptake of do-it-yourself passive investing is becoming more mainstream. “Are active managers about to lose their lunch – or their lives – to the passive barbarians pounding on the city gates?” This dramatic question is posed by Paul Stewart, the head of fund management at Grindrod Asset Management, in an article titled “Too soon for the obituary of active management”.
Stewart states that “the uncomfortable truth is that … many successful active managers have become fat and happy. The clients of active managers have often been sold the idea that their fund managers can divine the future. Perhaps not overtly, but certainly via a subtle nod and wink. “But statistics show that, on aggregate, active managers appear to charge higher fees for delivering below-average returns versus broad market indices,” he writes.
Does this mean you should pile into passively managed investments? “Not so fast, because this is only half the story. Amid all the debate and marketing hype from both sides, the investor’s need is often forgotten. The principal outcome of this discussion should the future – are able to command a premium fee. Whether this fee is at, above or below one percent is not instructive, he says.
Investors should evaluate fee fairness on the basis of how the fee is structured and the returns that are delivered. “The focus should always be on return outcomes after costs. If the cost is 1.2 percent a year, but the investor receives a 15-percent-a-year retur n over a five-year cycle, the after-cost value for money is better than if the cost is 0.5 percent and the return is 10 percent (all else being equal),” Cluer says.
“In short, it is possible to pay a premium price and receive a premium outcome. Likewise, it is possible that paying peanuts begets mediocrity. As the saying goes, cost is what you pay, value is what you get, and cost should only become the major issue when value is in question. The assessment of the reasonability of a fee must be calibrated as such.”
But passive managers dispute the ability of active managers to consistently outperfor m the returns of the market, and these can be harnessed by an indextracking fund.
HOW MUCH IS ENOUGH?
As for an optimal exposure to equities, Carter says while it is true that for long-term growth you need to have a substantial allocation to equities, it doesn’t automatically always be selecting the best strategy for the achievement of the individual investor’s long-term goal. The debate around whether an active or passive strategy is superior is a diversion, because actually there is no single correct answer to this perennial question,” Stewart says.
He says that, like your fingerprints, your investment requirements are unique to you. Each individual differs and therefore your investment term, tolerance for volatility, asset allocation and required income levels will differ from that of another investor. For this reason, very few individual investors are inherently suitable passive investors, Stewart says.
A passive portfolio may not have an appropriate asset allocation to fund your long-term income needs in retirement, Stewart says.
He also points out that the very act of selecting a passive portfolio, including the index you will track, the weightings in each asset class and the level of investment risk involved, requires making an active decision.
Passive investing may also leave you with complex decisions on how to rebalance your portfolio and how to manage your cash flow when you are drawing an income, Stewart says. follow that sticking to the maximum allocation will work best through thick and thin.
“It’s easy to draw that conclusion after a long period of great equity returns, but there have been periods, and there will be periods again, where the ability of a manager to reduce equity exposure can be very valuable. We believe that the ability of our fund managers to reduce equity exposure in the Allan Gray Balanced Fund is a valuable tool to protect investors’ capital in difficult markets that will produce superior returns over the long term.”
Cluer says that to achieve meaningful long-term inflation-beating returns, investors should indeed have “significant” exposure to growth assets. “But to put any percentage cap on the maximum equity exposure – equities are not the only growth assets – would be suboptimal, as investment risks change across the economic cycle.”
He says this is why you should entrust your savings to investment managers who:
• Have a multi-decade record of success in delivering inflation-beating returns across more than just one economic cycle;
• Build dynamically managed portfolios of multi-asset class securities, taking into account the prevailing investment risks and opportunities; and
• Charge a fair fee for the work undertaken.