Active? Pas­sive? Two view­points to con­sider

Num­bers tell dif­fer­ent sto­ries de­pend­ing on your ap­proach

Financial Mail - Investors Monthly - - Feature: Active V Passive Investing -

no “PAST PER­FOR­MANCE IS guar­an­tee of fu­ture re­turns.” Th­ese words any in­vestor — in­di­vid­ual or in­sti­tu­tional — will see on fund fact sheets or other lit­er­a­ture pro­duced by fund man­agers, writes Jo­hann Barnard.

This pru­dent cau­tion­ary no­tice is not only a reg­u­la­tory re­quire­ment but also an in­di­ca­tion of the mar­ket swings fund man­agers have to nav­i­gate. While the warn­ing is equally ap­pli­ca­ble to active and pas­sive funds, se­lec­tive data shows that the need for cau­tion in ac­tively man­aged funds is greater.

Ac­cord­ing to the S&P In­dices Ver­sus Active (Spiva) SA Score­card for 2015, active man­agers have con­sis­tently un­der­per­formed S&P bench­mark in­dices over the past five years. And the longer the time frame, the worse their per­for­mance.

Ac­cord­ing to the re­port, which was re­leased at the be­gin­ning of April, global eq­uity-fo­cused funds showed the worst per­for­mance (as mea­sured against the S&P global 1200 in­dex) over the five-, three- and one-year pe­ri­ods. The re­turns, that showed that 96%, 81% and 75% of fund man­agers were out­per­formed by the in­dex for the pe­ri­ods, is due par­tially to not only stock and coun­try se­lec­tion but also man­age­ment of the de­cline of the rand.

Lo­cal eq­uity funds per­formed a lit­tle bet­ter — com­pared to the S&P South Africa Do­mes­tic Share­holder Weighted In­dex — with 75%, 63% and 51% of active funds pro­duc­ing lower re­turns over the five-, three- and one-year pe­ri­ods.

Zack Bezuiden­houdt, head of S&P for SA and sub-Sa­ha­ran Africa, says this re­sult should not be sur­pris­ing. “Most active fund man­agers will un­der­per­form the bench­mark af­ter fees most of the time, with our data show­ing this fig­ure to be about 80% over a five-year pe­riod,” he says. “While some active man­agers are able to pick those stocks that out­per­form the mar­ket, a small num­ber of man­agers are able to do this con­sis­tently.”

This holds true for fund man­agers across the globe, not only lo­cally. Bezuiden­houdt says S&P has data for the past 15 years for US funds that bear this out. S&P Dow Jones In­dices pub­lish eight Spiva score­cards cov­er­ing Aus­tralia, Canada, Europe, In­dia, Ja­pan, Latin Amer­ica, SA and the US.

He says South African man­agers face a mul­ti­tude of chal­lenges brought on by the weak­en­ing cur­rency, mar­ket volatil­ity and the im­pact of the com­mod­ity price cri­sis.

“Active man­agers aim to pick those stocks that out­per­form the mar­ket. The prob­lem is that it is dif­fi­cult to do that in a pe­riod where cer­tain stocks are per­form­ing sim­i­larly to each other,” he says. “And the prob­lem fac­ing the big as­set man­agers is that they can’t in­vest in small and mid-cap com­pa­nies, which are show­ing a long-term mo­men­tum trend. When the rand went through a dif­fi­cult pe­riod last year, big fund man­agers that in­vested in large cap stocks with big global ex­po­sure, which pro­vided a rand hedge, did well. But given the long-term mo­men­tum trend in small caps, the large man­agers have been strug­gling, es­pe­cially in the first four months of this year.”

Rank­ings such as this should, how­ever, be taken with a pinch of salt, ar­gues Pi­eter Koeke­moer, head of per­sonal in­vest­ments at Coro­na­tion.

“The pur­pose of th­ese re­ports is to pro­mote a spe­cific way of in­vest­ing. If you want to track in­dex com­pil­ers you have to pay them a fee, so there is a strong mo­ti­va­tion for the in­dex providers to trum­pet any re­sults that show that the av­er­age active man­ager un­der­per­formed a cer­tain in­dex over a spe­cific pe­riod. Th­ese re­turn com­par­isons are not pub­lic ser­vice an­nounce­ments — it’s pure mar­ket­ing,” he says.

“What is quite clear is that the mar­ket is gov­erned by math­e­mat­i­cal laws we can’t es­cape from.

“Not all mar­ket con­stituents, in ag­gre­gate, can­not re­ceive above-mar­ket re­turns — active re­turns are gen­er­ated at the ex­pense of other mar­ket par­tic­i­pants.

“The ab­sur­dity of this ap­proach can be demon­strated by ap­ply­ing the same logic to an eval­u­a­tion of past per­for­mance by pas­sive funds. Over the past year, we had 10 pas­sive unit trusts in the gen­eral eq­uity cat­e­gory. The Alsi re­turned 3,2% for the year, while the max­i­mum re­turned by a pas­sive fund was 3,2%. The min­i­mum re­turn by a pas­sive fund was -8,9% and the av­er­age re­turn was -0,9%. “If you fol­low the logic, you should there­fore not in­vest in a pas­sive fund be­cause 100% of them failed to out­per­form the in­dex.

“Gen­er­al­i­sa­tion doesn’t help.”

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