Active fund managers treading troubled waters
The debate between active versus passive investments has been a debate which is turning out to be a mainstay of the South African investment space. While government is adamant that it is advising fund managers to adopt a passive investment strategy, the recent performances of the JSE index has put forward a serious case for active investment.
However, what is the future outlook for this strategy? etfSA.co.za reports that internationally, it is becoming increasingly difficult for fund managers to beat their respective indexes. The site adds that this is starting to become a feature of the South African market.
A frightening thought
Mike Brown, Managing Director of etfSA.co.za said that when looking at South Africa’s performance in the global context, South Africa’s active asset managers perform very badly. “For the period ending 30th of June 2014; on average, 82% of active unit trust managers fail to beat the target benchmark FTSE/JSE All Share index, over periods ranging from the past six months to twenty years,” says Brown.
He adds that there are a number of factors that are influencing this performance. According to Brown, the first influencing factor is the perceived narrowness of the local equity market. Ninety percent of all trades take place in the top forty shares on the JSE, so the average return of the market (Beta) is very accessible by purchasing a broad market index.
“The scalability of the local market is a key influencing factor. Outside of the top forty shares on the JSE, there are few companies with sufficiently large free floats of issued share capital, liquidity and tradability, to accommodate the needs of the top institutional investors. Often value active investors can get locked-in to smaller companies that fail to perform or fail altogether,” says Brown.
He adds that an influencing factor which needs to be looked at with some dedication is the role that foreign investment flows play in the market. Foreign investment flows, typically only target the major ten to fifteen shares in the market. These large capitalisation shares therefore make up the bulk of the performance in the market. They also dominate the index weightings. If you do not hold these core shares in portfolios, you run the risk of significant deviation from the index.
“Closet index tracking is becoming endemic in South Africa’s institutional investment industry. But if you charge active financial management fees towards benchmark hugging, you are bound to underperform the market,” warns Brown.
The news gets worse
Brown is certainly not pulling his punches and points out that there is even worse news for active fund managers. The number of active equity unit trust managers that beat the All Share index in the relatively short time periods, of six to twenty four months, is getting fewer and fewer.
“Looking at industry information, just six months ago on the 31st of December 2013 - 34,4% of active equity managers outperformed the All Share benchmark for the six month period; 35,8% over a twelve month period; and 28,2% over a twenty four month period. Only six months later, in June 2014, these percentages of active managers that have outperformed over the periods under review, fell to 15%, 19% and 15% respectively. This is a staggering drop,” says Brown.
Moving towards a more positive outlook
Brown concludes by saying that if this continues, the relevance of the active managers could be questioned. “If Beta performance becomes so accessible through passive index trackers, by definition Alpha, becomes more and more elusive.”
If the above information is an accurate reflection of the market and the challenges that active managers face, there is a serious case being made for a movement towards a passive investment strategy, especially with Treating Customers Fairly (TCF) outcomes being introduced to the market.
It will be interesting to see the role that TCF plays on the market. According to TCF principle three, customers are provided with clear information and kept appropriately informed before, during and after the point of sale. Will this mean that customers are informed if their investments are performing badly? If it does, will they then have the power to request a change in outlook? Are they sufficiently educated enough to know which investment strategy should be adopted at a specific time?
TCF will mean that there needs to be a close relationship between the adviser and find managers. This provides advisers with the opportunity to come into their own. By sitting down with clients and advising them on the influencing factors that are affecting their investments, advisers are making sure that they live up to the TCF principles that apply to them as well as giving customers the opportunity to work towards a comfortable retirement.
It may also kill the debate which is raging around the Retail Distribution Review (RDR). If an adviser is providing good advice to a client, many industry experts have said that clients will not be opposed to paying for this advice over and above the fee negotiated at sales stage.
Editor’s Thoughts:
The performance indicated by Brown may have very little to do with the fund managers ability and a lot to do with governments efforts to create a positive investment climate. Looking behind the scenes, government needs to do a lot in order to achieve the necessary financial stability that will guarantee a steady performance for active managers. We could be in for some interesting times for fund managers in the near future. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts jonathan@fanews.co.za.
Comments
I do not believe in market timing, but it is common knowledge that the JSE is due for a proper correction. We might not know when it will happen or by how much, but I respect managers that are already positioning their funds against any correction, even if this comes at the expensive of short term (-5 years) performance.
After all, the index is simply an aggregation all the investors participating in it. Deviation from the benchmark is a sign that the manager is at least trying to outperform his peers. Even if they might not achieve it at all times, there are managers that have proven themselves over the longer term. That's when having an advisor that continuously looks for proven out performers justifies the fees paid. Report Abuse