Positively passive

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