Fit for purpose
Since the global economic crisis, economies around the world have had to deal with an investment roller coaster as markets regularly shifted between stability and instability. Some markets have managed to weather the storm; others, like Greece and Brazil, have struggled to come to terms with this volatile new world that they find themselves in.
This feeds fuel to the debate over passive and active fund management and the debate as to which is the best strategy to follow in a market filled with volatility. If an adviser does sit down with a client to discuss the merits of active and passive management, perhaps it is worthwhile to make a list stating your argument for and against each strategy.
The cost factor
Cost containment is an important consideration. In a time of tight economic conditions, clients will look for ways to streamline costs by adopting a strategy which suits their long term saving journey.
One needs to come to terms with the fact that active management is costly. And rightly so; active managers take on a significant amount of risk on the promise that they will beat the benchmark set out by the market in order to maximise gains for their clients.
But how often are active managers beating the market? And are they beating it enough to warrant the fees they charge? This has been a debate in the South African market for a number of years and according to the Association of Savings and Investment South Africa’s 2014 Unit Trust Survey, on average, 15% of active managers will fail to beat the market benchmark in any given period over six months to 20 years.
The simplicity factor
Streamlined investing is a growing movement whereby clients try to make investing easier to the extent that they automatically create and maintain portfolios that fit long-term goals and risk tolerance.
This brings the merits of passive investment to the fore whereby an investment tracks the benchmark rather than trying to beat it. This is often achieved through simple methods – if investing can ever be referred to as simple – which are gaining traction globally.
One of the ways of achieving this simplicity is through the use of Exchange Traded Funds (ETF). Lance Solms, Director of Retail Distribution and Business Development at Itransact, points out that from humble beginnings, the ETF phenomena has grown to the stage where it is currently a $3 trillion industry.
The case for active
The above information is a very strong case for the advocacy of passive fund management. However, there is still a place for active management in society. Everyone would love to beat the benchmark, and there is no better time to do it than in the present when the market is sluggish.
This is even true in the US where, according to a report by the Wall Street Journal (WSJ), clients pulled $98.58 billion out of actively managed US stock mutual funds while putting $71.34 billion more into passive funds.
The report went on to add that many advisers still believe that at certain times, and for certain strategies, actively managed funds are superior to index funds. That is particularly true if the active fund has a good long-term track record, and charges lower management fees than most of its peers. One again it comes down to fees.
One of the times when active management can be a benefit is during times of volatility; active managers have more ways to play defence. The WSJ report shows that active managers can own higher-quality stocks and trim positions as valuations rise. They don’t have the pedal to the metal when the markets are going up, and they put the brake on more quickly when markets are going down.
Performance numbers can help identify such funds. One such indicator is upside and downside capture ratios, which show how a fund’s returns compare with the broad market in rallies and selloffs.
Editor’s Thoughts:
Hindsight is 20/20 vision, one cannot plead the case for passive management without highlighting the advantages of active management. At the end of the day, it comes down to your client and following TCF principles. Which form of management do you feel is best in the current South African market? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts [email protected].
