Active or passive investing?
The choice between active and passive management has stirred a perpetual debate in the field of asset management. Active management is a style of investing that focuses on outperforming the market by employing strategies such as short-selling, leverage, quantitative methods, investing in alternative assets such as art and cryptocurrencies, and so forth. When executed successfully, active management strategies can generate alpha, which is the excess return of an investment relative to the return of a benchmark index. On the other end of the spectrum is passive management which focuses on mimicking stock market returns by closely tracking the benchmark index.
The obvious advantage of actively managed portfolios is the above-market returns. However, poor execution of active portfolio management strategies can lead to investment returns that fail to beat the market. Passive management styles do not generate returns in excess of the market but when they fail to beat the market, they are often closer to the benchmark than actively managed portfolios. Passive investment strategies take after their name and involve less trades in comparison to active strategies. This opens active portfolio management to higher costs that stem from the relatively high volume of trades as well as other costs incurred in other active strategies.
Although active management looks enticing for novice investors, its appeal in developed markets has waned in the last decade. An article by the Wall Street Journal revealed that, over a 15-year period ending in 2016, 82% of all actively managed US funds trailed their respective benchmarks. In addition, statistics from Morningstar show that only 17% of the mutual funds included in the Morningstar US Large Blend Category outperformed the Russell 1000 Index for the five years ending in December 2016. Latest figures from Bloomberg revealed that only three hedge funds globally outperformed the S&P 500 in 2021. These numbers underpin the movement of funds from actively managed funds and into passively managed funds between 2010 and 2020. Armed with these statistics, many proponents for passive management have been gaining traction over the years. However, this has not been the case in global ex-US markets. Additional statistics from Morningstar also show that 60% of emerging markets equity funds in the Morningstar Diversified Emerging Markets Category beat the MSCI Emerging Markets Index, and 64% of international equity mutual funds in the Morningstar Foreign Large-Blend Category beat the MSCI All-Country World ex-US Index.
There are several factors that could explain the stark difference between hedge funds in the US and those in other markets, and we opine that two of them are the efficiency and depth of capital markets. According to the World Economic Forum’s global competitiveness rankings, developed economies such as the US, Canada, and Hong Kong score highly on financial markets development while developing countries like Zimbabwe, Mozambique, and Burundi hold some of the lowest ranks among 140 surveyed countries. Financial market development in this context includes efficiency, availability and affordability of financial services, financing through local equity markets, ease of access to loans, and regulation of securities exchanges, among other factors.
We opine that more efficient and deeper capital markets offer less opportunities to earn alpha. The availability of financial instruments such as swaps, futures, and options in developed markets allow for efficient pricing mechanisms in the underlying assets which reduce the volatility of the prices of the underlying assets. This is complemented by high capital mobility that limits opportunities for arbitrage or riskless profits as well as ease of access to material information in developed markets. This is not the case with many other capital markets that are less developed. Zimbabwe, for example, has very low capital mobility, fewer financial instruments, and high information asymmetry that limit price discovery and offer good ground for actively managed portfolios to thrive. As a result, it is easier for funds in emerging and other international markets to beat their benchmarks compared to funds invested in developed markets.
In Zimbabwe, exposure to active management styles can be through the equity fund offered by Old Mutual Zimbabwe. The fund aims to provide capital growth over the medium-tolong term and uses the ZSE All Share Index as the benchmark. In the year 2021 to September, the fund achieved a 9-month return of 480,4% versus a growth in the ZSE All Share Index of 423,8%. A factsheet of the fund is available on Old Mutual Zimbabwe’s website, and it is available on the CTrade platform.
Along the spectrum of active and passive investing is a combination of both active and passive investment styles. These styles of investing are common in actively managed exchange traded funds. These instruments attempt to beat the benchmark while boasting a low-cost structure. Exposure to such an instrument in Zimbabwe is now possible through the newly minted Morgan&Co MultiSector ETF. The ETF aims to earn alpha for investors by taking long positions in fundamentally undervalued sectors. The ETF is benchmarked against the ZSE All Share Index and is readily available on C-Trade and ZSE.
At the other end of the spectrum in passive investment, investors seeking to employ this portfolio management style have the option to invest with Old Mutual’s Top Ten ETF that is also available on C-Trade and ZSE. This ETF was launched in 2021 and it mimics the constituents of the ZSE Top Ten Index which are market-cap weighted. These three instruments offer an affordable way to reap market-related returns without getting into the nittygritty of investments analysis such as; which counters to invest in, when to invest in and out of stocks, minimising risk, and efficiently diversifying a portfolio.