Active and passive management : Time for a marriage proposal
Roland Gräbe, Head of Tailored Fund Portfolios at Old Mutual Wealth.
The age-old debate of active versus passive continues to be one of the most highly contentious topics within the investment management space.
The debate is mainly driven through asset managers who have a vested interest in promoting one above the other. This bias in the conversation can lead to a lack of objectivity. The result is that advisors and clients are left confused by a debate that creates the impression that only one side can be right.
This is according to Roland Gräbe, Head of Tailored Fund Portfolios at Old Mutual Wealth, who says that a large portion of the active versus passive debate completely misses the mark in this sense, particularly from a financial advice perspective. “In terms of the implementation options that are available to financial planners in creating the most beneficial investment solutions for clients, it does not need to come down to choosing one investment strategy over the other.”
Of course, any passive manager will argue that active managers rarely add value after their higher fees and picking active winners can be somewhat of a gamble; while those on the opposing side will argue that success is possible with active management, possibly even pointing out that some passive strategies are not much cheaper than their active strategies.
“However, as a financial planner, is this debate even relative to you?” questions Gräbe. “Ultimately your clients just want their wealth to grow over time, and the key driver in determining this growth is asset allocation, rather than asset manager selection. Your focus in terms of active versus passive should therefore be on how a blended approach can better help your clients achieve above-inflation returns.”
As some markets look more attractive to active management, while others look more attractive to passive management, Gräbe suggests blending strategies within each asset class. “Think of a market cap index fund as another manager you can appoint within each asset class, based on its merits versus active managers. Having this manager in, for example, a global equities portfolio will drive down your costs, as well as give you some predictability in terms of the return you’ll get relative to the market.
When it comes to other asset classes, however, using a passive approach might be less attractive based on cost and risk management considerations. Furthermore, in South Africa, the options available in the property space or the bond market are more limited, and gaining exposure to commodities, inflation-linked bonds and hybrid asset classes will also be a struggle, as these might be neglected in a purely passive approach.
While blending active and passive balanced funds is an option, Gräbe warns against giving up control over asset allocation. He says that ultimately, advisors have no control over the end result when blending balanced funds. Costs can also become an issue here, as investors end up paying both managers for security selection and asset allocation, and they run the risk of incurring significant performance fees.
Through some research and applied thinking, Gräbe says that it is possible to develop a well-constructed capital growth strategy that considers a blended approach according to the merits of each asset class. “While it may require some added due diligence, you retain control of your client’s investment risk and can relate it back to their real return. By using passive managers where it makes most sense, you are able to lower your overall cost structure, but there is also the option of combining passive and active managers where there is no clear winner.
“Approaching a financial plan in this way allows for easier manager and index selection, because when you look at an asset manager in a specific asset class, the track record will tell you how this manager has performed in the current specific market. You can then also dig into their process and understand their investment philosophy.” With balanced funds this is much more complex, because of the number of drivers of risk and return underpinning fund performance.
Gräbe concludes that a blended approach can be executed in a number of ways. “It might be that you can do all of this yourself, or perhaps you prefer to partner with a discretionary fund manager. There is also the option to fully outsource to a multi-manager, however, it is important to ensure that your selected multi-manager has the requisite skills to implement such a robust approach.”
