Both ac­tive and pas­sive funds can de­liver, if you stick with them

No clear distinc­tion between the two strate­gies

Weekend Argus (Saturday Edition) - - LIFE - PA­TRI­CIA HOL­BORN

It can be dif­fi­cult to de­cide where to in­vest your money and how ac­tively you want your money to be man­aged. You can rely on ac­tive and pas­sive man­agers to quote reams of stud­ies and sta­tis­tics to prove that their re­spec­tive ap­proaches are right. Three ac­tive and three pas­sive fund man­agers ex­plored the mer­its of th­ese in­vest­ment strate­gies at the re­cent Core­shares in­vest­ment sem­i­nar held in Sand­ton.

Their con­clu­sion? Many ac­tive man­agers do un­der-per­form their bench­marks, but many out-per­form their bench­marks and com­pa­ra­ble pas­sive funds. If in­vestors stick with one in­vest­ment strat­egy and man­ager for the long term, ei­ther strat­egy can work.

The main dif­fer­ence between ac­tive and pas­sive in­vest­ing is that, with ac­tive man­age­ment, you rely on the man­ager to se­lect the right shares, out-per­form the mar­ket and earn the re­turns you need. With pas­sive in­vest­ing, you rely on mar­ket per­for­mance to de­liver the re­turns you re­quire.

Those in favour of pas­sive man­age­ment like to quote sta­tis­tics such as the S&P In­dices Ver­sus Ac­tive score­card (Spiva), which showed that over half of ac­tive fund man­agers in Canada, the United States, Europe and Aus­tralia un­der-per­formed their bench­marks over the five years to the end of De­cem­ber 2015. In South Africa, 74 per­cent of do­mes­tic eq­uity funds un­der-per­formed their re­spec­tive bench­marks, Spiva found.

That’s quite a per­sua­sive ar­gu­ment in favour of pas­sive in­vest­ments, par­tic­u­larly when you con­sider that most ac­tively man­aged funds have higher fees than pas­sively man­aged in­vest­ments.

The lower fees charged by pas­sive funds con­trib­ute sig­nif­i­cantly to their out-per­for­mance, be­cause high charges eat into re­turns.

A study by Morn­ingstar that an­a­lysed funds in the US found that fees were a strong pre­dic­tor of suc­cess, with the cheap­est funds at least two to three times more likely to sur­vive and out-per­form their peers, Ne­rina Visser, a direc­tor of et­fSA, told the Core­shares con­fer­ence.

Pas­sive man­agers of­ten ac­cuse ac­tive man­agers of fail­ing to add re­turns over and above what the mar­ket re­turns. This con­tention has been sup­ported by aca­demic re­search over the years. For ex­am­ple, a 1986 study of 91 large US pen­sion funds found that 90 per­cent of per­for­mance was the re­sult of mar­ket move­ments, Visser said.


Nev­er­the­less, ac­tive fund man­agers be­lieve they of­fer in­vestors a good chance of earn­ing higher-than-mar­ket re­turns.

Ac­tive fund man­agers point out that, just be­cause the av­er­age No in­vest­ment is com­pletely pas­sive, Ne­rina Visser, a direc­tor of et­fSA, told the Core­shares con­fer­ence in Sand­ton re­cently.

A pas­sive in­vest­ment tracks an in­dex, but the de­ci­sions taken in select­ing and con­struct­ing that in­dex are made ac­tively.

Pas­sive in­vest­ments range from those that track a mar­ket­cap­i­tal­i­sa­tion in­dex, such as the FTSE/JSE Top 40 In­dex, to those that track an en­hanced in­dex aimed a cap­tur­ing cer­tain driv­ers of re­turns or fac­tors op­er­at­ing in fi­nan­cial mar­kets. Th­ese funds are known as smart man­ager doesn’t con­sis­tently out-per­form its bench­mark, it does not mean that all ac­tive fund man­agers un­der-per­form. A look at the per­for­mance of five ac­tively man­aged do­mes­tic eq­uity gen­eral funds over the five years to June 30 proves the point: four out-per­formed their bench­mark and one un­der- per­formed it by one per­cent.

Owen Nkomo, an ex­ec­u­tive part­ner at, and founder of, in­vest­ment ad­vi­sory busi­ness Inkunzi Wealth Group, told the con­fer­ence that an ac­tively man­aged fund can avoid un­der-per­form­ing se­cu­ri­ties, with the re­sult that in­vestors will ex­pe­ri­ence smaller draw­downs, or pe­ri­ods beta funds, and an ex­am­ple is an in­dex fund that tracks the FTSE/JSE Div­i­dend Plus In­dex.

Funds that track a mar­ket­cap­i­tal­i­sa­tion in­dex in­vest in shares in line with their mar­ket cap­i­tal­i­sa­tion (the price of the se­cu­ri­ties mul­ti­plied by the num­ber in is­sue) in the in­dex, which rep­re­sents a mar­ket. If a share makes up 20 per­cent of a mar­ket, the fund will hold 20 per­cent of that share.

Smart beta funds con­struct their own in­dices to track. It is ar­gued that ex­po­sure to cer­tain fi­nan­cial or mar­ket fac­tors en­ables th­ese funds to pro­vide a bet­ter re­turn than the when re­turns are neg­a­tive.

If the mar­ket falls 10 per­cent, a pas­sively man­aged fund will fall 10 per­cent. The man­ager of an ac­tively man­aged fund can avoid a sim­i­lar mar­ket draw­down with care­ful share se­lec­tion.

There is no guar­an­tee that an ac­tively man­aged fund will not ex­pe­ri­ence a sig­nif­i­cant draw­down if the mar­ket falls, but, de­pend­ing on its in­vest­ment style, an ac­tive man­ager is able to se­lect in­vest­ments that will not fall as much as the mar­ket.

Your fi­nan­cial ad­viser should mon­i­tor draw­downs to as­sess whether your ac­tive fund man­ager mar­ket, or to re­duce some of the risk of in­vest­ing in the broader mar­ket, at a lower cost than ac­tive man­agers.

Some ex­am­ples of smart beta funds are low-volatil­ity funds and funds that track high-div­i­dend-pay­ing com­pa­nies.

Many in­vestors com­bine pas­sive and ac­tive in­vest­ments in a core­satel­lite ap­proach to in­vest­ing, where a large part of the port­fo­lio – the core – is al­lo­cated to pas­sive. The satel­lite in­vest­ments are of­ten ac­tively man­aged funds with ex­po­sure to niche in­vest­ments, such as small­cap­i­tal­i­sa­tion funds. has avoided draw­downs in the past.

Be care­ful of com­par­ing as­set al­lo­ca­tion funds to pure eq­uity funds when you look at draw­downs. The man­ager of a multi-as­set fund, which al­lo­cates to dif­fer­ent as­set classes, such as shares, bonds, listed prop­erty and cash, can sell equities and move into cash to avoid draw­downs. The man­ager of an eq­uity fund can man­age draw­downs only through share se­lec­tion.

There is no guar­an­tee that an ac­tive man­ager will de­liver good re­turns and avoid poor per­form­ers. Although you can con­sider a man­ager’s per­for­mance track record and try to un­der­stand its in­vest­ment phi­los­o­phy, past per­for­mance is not a guar­an­tee of fu­ture per­for­mance.


An ac­tive or a pas­sive strat­egy can ben­e­fit in­vestors. Which one is right for you? If you are sat­is­fied to earn what the mar­ket re­turns, a pas­sive in­vest­ment could be suf­fi­cient over the long term. How­ever, if you want to earn re­turns that beat the mar­ket, you need an ac­tive man­ager or an en­hanced in­dex fund.

If you in­vest in ac­tively man­aged funds, you have to choose the fund man­agers care­fully. This means you need to re­search man­agers, and un­der­stand how they man­age funds and their ap­proach to in­vest­ing, Nkomo said.

It is not easy to se­lect man­agers that will out-per­form con­sis­tently, be­cause the top-per­form­ing man­agers in one year are of­ten not the top-per­form­ing man­agers in the fol­low­ing year. If you re­bal­anced your port­fo­lio ev­ery year, based on select­ing the man­agers whose per­for­mance placed them in the top quar­tile, you would have to change 85 per­cent of the man­agers in your port­fo­lio, He­lena Con­radie, the chief ex­ec­u­tive of­fi­cer of Sa­trix, told the con­fer­ence.

A study by Core­shares found that, over the 10 years to the end of April, there was only a 0.7-per­cent prob­a­bil­ity of select­ing a port­fo­lio of three funds where all three would out-per­form the in­dex, Chris Rule, the ex­ec­u­tive of cap­i­tal mar­kets at Core­Shares, said.

Ac­cord­ing to a March 2015 re­view by US-based mu­tual fund man­agers Hotchkis and Wi­ley of the stud­ies into ac­tive and pas­sive in­vest­ments, three facts are agreed on: first, the av­er­age ac­tive fund man­ager un­der-per­forms a pas­sive bench­mark af­ter fees; sec­ond, some ac­tive man­agers do out-per­form. Third, and pos­si­bly most im­por­tantly, the ac­tive man­agers that out-per­form are high-con­vic­tion in­vestors (they have a strong be­lief in their in­vest­ment strat­egy and process).

Dur­ing a de­bate at the con­fer­ence, two of the three pas­sive man­agers dis­closed that they had ac­tive in­vest­ments, but none of the three ac­tive man­agers said they had pas­sive in­vest­ments.

There is no clear win­ner in the ac­tive or pas­sive de­bate. Some­times one works, some­times the other, and some­times a com­bi­na­tion of the two is best.

Ac­tive man­age­ment may re­quire you to do more home­work, be­cause it takes re­search to se­lect a man­ager that has a chance of be­ing bet­ter than av­er­age. If you are pre­pared to put in the time, and have a good knowl­edge of in­vest­ments, you might pre­fer this op­tion.

An im­por­tant fac­tor all in­vestors need to suc­ceed is pa­tience. In­vestors must stick with their in­vest­ment strat­egy for the long term, rather than switch­ing fre­quently.

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