Index investing: How it started vs how it’s going

The first index fund launched in the United States in the 1970s, and the industry has since gone through many transitionary and growth periods. Since the global financial crisis between 2008 and 2009, there has been an acceleration in adoption of index tracking products globally, especially in the US. This came about due to various reasons including underperformance by active fund managers, regulation, and a low yielding environment.

The South African index investing industry isn’t quite as old but still stems back to the mid-90s with the first Exchange Traded Fund (ETF) launched on the JSE in 2000. In the last 20 years, there has been a proliferation of Exchange Traded Product (ETP) listings on the JSE, which includes ETFs and Exchange Traded Notes (ETNs).

Since 2008, the value of total JSE-listed ETPs has increased by 657%. There are currently 85 ETFs with a market value of R112 billion and 87 ETNs with a value of R18 billion listed on the JSE. This is indicative of the growth in the SA Index Investment Industry within the last 25 years.

Although the number of ETFs listed in SA is smaller than that of the US and UK where there are over 1 000 ETFs listed on each exchange, it is important to note that the SA market is still well placed compared to more developed markets. SA index tracking products cover most asset classes and geographies, allowing investors to use index tracking products to construct a well-diversified, multi-asset investment solution.

However, SA does lag in terms of market share where index tracking products constitute less than 10% of the savings pool, which is low compared to the US and Europe, where the share sits at around 30%. The main contributors to slower market penetration in SA can be attributed in part to initial hesitancy around whether passive investing would necessarily work within an inefficient market. However, over the last few years, various surveys have proved that the case from a performance perspective in the US holds true in SA.

In addition, direct investing or DIY investor was a big drive in the Global adoption. South Africa is still heavily intermediate, and that is a function of the financial literacy of South African investors are lower than that in US and Europe. Increased regulation and financial literacy along with maturity in the advice process are expected to close the gap in coming years.

There has also been a realisation that index tracking products are the best way to unbundle returns, where previously your returns were at the discretion of the fund manager’s choices, investors and advisors are now able to gain the same exposure by investing directly into an index tracking product mimicking the asset class in which you seek exposure.

What does the future hold?

The future of index investing is likely to be defined by the two cs (choice convergence) as well as transparency and value. Today, global index provider MSCI calculates 250 000 indices daily, which is expected to increase to 25 million indices in 10 years. As more indices are created, product providers will create more products and choice for investors will become plentiful. Given that there will be a lot more choice, the role of financial advisor will be very important to help investors decide based on their unique goals and view that they may want to express.

Secondly, it is expected that there will be a convergence of active and passive products where there will be hybrid of the two product types, giving rise to actively managed funds listed as ETFs. Transparency will become more important in the future around the product, its strategy and associated costs, and strategy and index tracking products allow clients more insight as to what is driving their return, and how much they are paying for that return.

Finally, there will be increase in value and volume, with index tracking products expected to increase in global market value as they shift from being standalone products to client solution products. In SA specifically, where the market is shifting offshore for discretionary savings there will ultimately be an in increase in the growth of index investing – from both a market share and product perspective.