Pos­i­tively pas­sive

Financial Mail - - INVESTOR’S NOTEBOOK - @scranston by Stephen Cranston

James Downie may well be the best as­set con­sul­tant in SA. He has an in­de­pen­dent mind­set and a wealth of knowl­edge. So I couldn’t ig­nore it when he weighed in on the ac­tive-ver­sus­pas­sive in­vest­ing de­bate. Veteran in­vestor Charles El­lis told us at a re­cent “fire­side chat” with my friend in­de­pen­dent fi­nan­cial ex­pert Candice Paine that in­dex in­vestors should never have been called “pas­sive”. It is hard to feel pos­i­tive about any­one who is de­scribed as pas­sive and, in con­trast, “ac­tive” has over­whelm­ingly pos­i­tive as­so­ci­a­tions. El­lis made a for­tune as an ac­tive man­ager and he is now a prime mover of sim­ply rid­ing the growth in the mar­ket pas­sively.

Downie says ac­tive in­vest­ing is easy to de­fine — it is the style of an in­vest­ment man­ager that takes ac­tive bets away from a par­tic­u­lar in­dex, in­vest­ing more in cheap shares and less in ex­pen­sive shares through clever stock se­lec­tion to beat the in­dex.

Some in­vestors don’t even con­sciously weigh their port­fo­lios against the in­dex, but op­er­ate on a “clean sheet” ba­sis. And they work on the as­sump­tion that the mar­ket is ir­ra­tional: there is of­ten more psy­chol­ogy than math­e­mat­ics in ac­tive man­age­ment.

El­lis jokes that fund man­agers used to beat the in­dex more of­ten in the 1960s, when they were pri­mar­ily lib­eral arts grad­u­ates, than they do now that most have fi­nance qual­i­fi­ca­tions.

Downie agrees with El­lis that “pas­sive” im­plies that both the in­vestor and the in­vest­ment man­ager are ly­ing back and do­ing noth­ing, not even en­joy­ing them­selves.

But there is noth­ing pas­sive about con­struct­ing an in­dex-based port­fo­lio.

An in­vestor might want to track the US mar­ket, but how is this de­fined? Should in­vestors track the bell­wether Dow Jones, the broader S&P 500, the new-economy-fo­cused Nas­daq or the widest of the ma­jor in­dices, the Wil­shire 5000? Over one year there would have been a 5.3% re­turn from the Dow — a poor bench­mark, as it con­sists of just 30 equally weighted shares cho­sen by the edi­tors of The Wall Street Jour­nal to re­flect the US economy. Yet it thumped the 2.7% from the Wil­shire with its long tail of small caps. And over five years Nas­daq has been the best per­former.

Even in SA there is a pro­lif­er­a­tion of in­dices. Should in­vestors go for the all share in­dex 40? This would be an ac­tive de­ci­sion to ig­nore mid caps and small caps. Or the share­holder-weighted in­dex (Swix), which down­weighs dual-listed shares; or the new Capped Swix, which has only one pur­pose — to re­duce the bench­mark weight­ing of Naspers?

Low-fee at­trac­tion

Downie says even the global in­dices give dif­fer­ing re­turns. He says the MSCI all coun­try world has given a 5.5% re­turn over five years and the FTSE all world 6.2%.

For many in­vestors the at­trac­tion of in­dex track­ers is low fees. Yet there are pas­sive in­sti­tu­tional prod­ucts in SA that charge 0.35%, an eye-wa­ter­ing amount for a pas­sive fund.

In­dex track­ing should start get­ting trac­tion once in­vestors can pay the five to eight ba­sis points charged by global houses such as Van­guard and Black­rock. Fi­delity now of­fers pas­sive prod­ucts at zero fees, pre­sum­ably as a kind of su­per­mar­ket loss leader — clients may be en­ticed to use its ac­tive funds and re­tire­ment ad­min­is­tra­tion ser­vices.

It is true that in­dex-track­ing houses such as Syg­nia and 10X of­fer a good deal, rel­a­tive to the to­tal cost of a stand­alone fund or even a main­stream um­brella fund. But know what you are buying: 10X fol­lows a pro­pri­etary in­dex, not the ones you have heard of.

There is of­ten more psy­chol­ogy than math­e­mat­ics in ac­tive man­age­ment

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