Knowledge free-for-all tests active fund gurus
Still room for sharp pencils and bold investment ideas?
● Active fund managers have lost their competitive edge in a world of globalised investing dominated by skilled professionals with access to good research, says Charles Ellis, a leading investment consultant and author.
But a top local manager says there is still room for active managers with sharp pencils and who are bold enough to be different.
Ellis, the founder of Greenwich Associates, a leading US-based investment consultant and author of Winning the Loser’s Game, says that in the 1960s only 10% of trading on the New York Stock Exchange was done by a few thousand investment professionals with access to in-depth research.
The rest was done by uninformed independents trading occasionally without much insight into the shares they bought or sold.
Today, more than 99% of the trading is done by more than a million smart, skilled professionals — “all equally informed, equally armed, equally equipped”, Ellis told Cape Town and Johannesburg audiences at an event hosted by local index-tracking investment manager Satrix recently.
The average major securities firm now has 500 to 600 analysts, economists, portfolio strategists and accounting and commodity experts with MBAs, PhDs or certified financial analyst qualifications, and use extraordinary computing power and models to analyse market data, Ellis says.
“There is nothing you can’t find out about investments rather quickly from several different sources today.”
When Ellis started as an investment consultant 50 years ago, it was “an extraordinary time” for active managers to “be different and have a competitive advantage” — managers had a six-month advantage to act on research about companies, bonds weren’t traded much and international shares made up only 1%-2% of portfolios.
But now a lot of information is available. “We make faster decisions, we make wider choices. Everyone is investing on a worldwide basis. It is wonderful what we have going for us. But we all have it,” he says.
“At some point the number of talented people in active investment management times the amount of information times the magnitude of computing power will equalise everybody into a cauldron of brilliance and hard work. But you can’t get ahead of the excellence that everyone else has.”
Today you have to buy shares from and sell them to people who know as much as you do, which doesn’t leave much to cover the cost of operating an active management business and investment fees, Ellis says.
“Index tracking is the only smart alternative because the costs of competing with active fund managers are too high.”
But not all active fund managers are ready to let index-tracking investment providers take over.
Richard Garland, head of global advisory for local active manager Investec, told its advisers recently that index-tracking investments are causing major and rapid changes in the industry and putting huge pressure on active managers to reduce their fees.
But he says active managers who manage money in a way that is very different to the benchmark index can generate returns in excess of the benchmark.
Clyde Rossouw, the manager of Investec’s Global Franchise Fund, says index-trackers “encourage us to sharpen our pencils, work harder and continue to differentiate ourselves from people trying to eat our lunch”.
MSCI, the global index provider, now publishes enhanced indices including the MSCI quality index, made up of “quality shares” of companies with good profits, strong and persistent earnings and a strong balance sheet.
The index is said to mimic the decisions active managers make, but Rossouw says relative to the MSCI quality index his fund has an “active share” — the percentage of shares that differ to the index — of 86%. This active stock-picking has enable the dollardenominated Global Franchise fund to outperform its benchmark index, the MSCI world index, by 1.8 percentage points a year over the past 10 years.
As the US is raising interest rates and withdrawing liquidity from that market, shares need to be carefully selected on valuations (their price relative to their potential earnings), Rossouw says. Defensive shares have to be balanced with faster-growing “exciting” ones likely to benefit from the rising digital economy, he says.
Rowan Williams-Short, a fixed-interest portfolio manager at Vunani, says index tracking has many virtues, but these are overstated and peddlers of these strategies are silent on the many shortcomings.
Passive-fund providers offer only funds that are convenient for them, rather than those that suit investors’ needs. For example, in SA you won’t find a passive mid- or smallcap equity fund, as such funds are too difficult for passive providers to offer, he says.
Williams-Short says index-tracking is a “dumb idea” in some asset classes. A passive global government bond fund would track the world’s most indebted nations, and many such bond markets, like Japan, trade at desultory yields, he says.
In SA, there is no plausible case for tracking the all bond index as most active managers routinely outperform it, and earn higher yields from corporate bonds. The passive industry does not offer a corporate bond fund, he says.
In the US, 50% of new investments are in index-tracking funds and the first large manager, Fidelity Investments, has launched two zero-fee funds tracking the US and international markets. The manager is earning fees through scrip lending — lending out the shares the fund holds, Garland says.
Some US commentators predict the trend will reverse during a bear market when passive funds could lose as much as the market — but Garland disagrees.
He says portfolios are increasingly put together by discretionary investment managers who charge a fee to select or “wrap” underlying funds. These managers typically invest about 30%-40% of the portfolio in lower-cost index-tracking investments to reduce the overall fee you pay, Garland says.
Ellis says the investment profession must recognise that it has become so good at share-price discovery that it needs to concentrate its efforts on helping investors figure out what they are trying to accomplish.