Are you doing right by your investment clients?
There are few tougher jobs than managing other people’s money; yet each day, thousands of certified financial planners (CFPs) and financial advisers are called upon to do just that. How you ‘go to bat’ for your clients could make the difference between ending a season in the top decile of the return performance tables for specific risk categories or languishing near the relegation zone. It turns out that doing right by your clients could be far simpler than first assumed. All that is required, according to the team at Satrix Investments, is the right balance of diversification and time-in-the markets. Oh, and a healthy dose of passive investment.
Pro passive musings from the pioneers of index tracking
Website Investopedia.com describes passive management as ‘a style of management associated with exchange-traded funds (ETFs) and [unit trusts] where a fund’s portfolio mirrors a market index … passive management is the opposite of active management, in which fund managers attempt to beat the market with various investing strategies and buying or selling decisions’. Passive management is also referred to as index investment or passive investing. To ‘balance’ this pro-passive piece, the writer must share that Satrix Investments is the self-branded “pioneer of index tracking” in South Africa. To further set the scene, the event was mainly focused on reviewing the Nedgroup Investments Core Chartbook 2022, which unpacks trends in local and offshore index and / or rules-based funds.
The first point of order was for Kingsley Williams, Chief Investment Officer at Satrix, to reflect on the growing popularity of passive investing. “Around 31% of global assets are now in some form of index or rules-based investment strategy,” he said, before adding that fund flows into passive strategies tended to be more consistent than those into active strategies. Williams used various charts to illustrate the growth of index and rules-based strategies in the domestic market among both the ETFs and unit trusts offered in the collective investment schemes (CIS) universe; pooled life vehicles; and funds with segregated mandates. By end-December 2022, roughly 14% of assets under management (AUM) in the listed equity space, across all Association for Savings and Investment South Africa (ASISA) sectors, were managed according to some form of index or rules-based strategy.
Surely active passive is active?
This writer always cracks a wry smile when he hears disciples of passive investing talk about ‘active passive’ strategies, in this case also referred to as non-vanilla passive strategies. Any index tracker that is market cap weighted is thought of as vanilla or plain vanilla: for example, an equity ETF that tracks the JSE Top 40. But there are now many passive funds that “track indices [without] necessarily taking a market cap weighted index approach”. Under this heading you might find funds that deploy factor- or thematic-focused strategies or other techniques in search of so-called smart beta. “Non-vanilla strategies make up in excess of a quarter of the AUM within the passive subset locally,” noted Williams, again illustrating that your clients cannot resist ‘a little something extra’ when investing their hard-earned cash.
There were some interesting developments in the high equity multi-asset or balanced fund space during the financial market turbulence of 2020 to 2022. The 10 largest actively managed balanced funds dominated both AUM and investment flows under this category; but during these years there were significant flows out of these funds. “During the three-year period, we saw some of the largest flows into indexed or rules-based balanced funds, [reaching a peak in 2022 when] more than a third of net flows into the high equity balanced category went into passive strategies,” said Williams. These statistics confirm the growing adoption of indexation strategies domestically. Satrix Investments has been a significant beneficiary of this trend shift and the firm’s AUM has grown steadily over the past few years, with the market adopting Satrix’s strategies within their portfolios across a variety of different investment vehicles.
You get what is says on the tin
Nico Katzke, Head of Portfolio Solutions at Satrix shared some Boston Consulting Group analysis that showed that the equity and fixed income ETF segments would attract the most capital between today and 2025. “In the future, our market will align with the global experience of seeing more flows into lower margin funds [such as] passive equity and fixed income, or unit trusts that have an index approach; we are seeing more flows into rules-based strategies globally as well as locally,” he said. Investors favour passive investments for three reasons. First, cost efficiency; second, the predictability around strategy design and implementation; and third, performance. “You get what it says on the tin; and that level of predictability is highly prized by investors,” Katzke said.
Gielie de Swardt, Head of Retail Distribution at Sanlam Investments, who served as the discussion moderator, asked Kingsley about the asset class performances from various passive funds during a turbulent 2022. “Over the last year, nothing beat inflation … in real terms, everything made a loss,” confessed Kingsley… He warned, however, that 12-months was too short a time horizon for investors in most passive investment strategies. Over longer time horizons the returns largely follow the risk associated with each asset class. For example, local equities and local property have delivered healthy above-inflation returns over rolling 10-year periods.
On asset allocation and diversification
It is impossible to comment on all the aspects covered during this fast-paced discussion. Katzke and Kingsley shared their views on emerging versus developed markets; offshore versus onshore; and the shift from growth and momentum towards value investment methodologies, before commenting on diversification as a tool to survive market turbulence. “Research shows that up to 90% of your long-term returns are explained by the exposures you have to various asset classes, in other words your strategic asset allocation,” Kingsley said. “That is the most important thing to decide [and you must] make sure that your allocation is appropriately matched to your investment horizon and your risk profile”.
In this context, Satrix focuses on designing solutions that get the strategic asset allocation right for clients that fit within a particular risk categorisation and / or to achieve a particular risk outcome. There is extensive evidence to support that the probability of delivering a negative return reduces with risk and time in the market. “In riskier asset classes you have quite a high probability of delivering a negative return over a short period of time, he said, noting a one-in-five change of a negative return on a rolling 12-month basis from equities. “As you expand your investment horizon to the medium term, you see that probability drop quite dramatically, particularly for local equities,” Kingsley said. “And over any rolling 10-year period going back to 2002 you have never had a negative return from our local equity market”.
Time in the markets is the best way to smooth returns
We conclude, however, with one of the undisputed gems from the hour-long presentation. Quoting Eugene Fama, widely acknowledged as the ‘father of modern finance’, Kingsley noted that “those how are looking to exit risky assets after a negative return should probably not have been in those risky assets in the first place … you need to have more than five years to have real confidence that you will not see a negative return”.
Writer’s thoughts:
This Satrix webinar showed the importance of matching clients’ asset allocations with their risk appetites. It also showed that index or rules-based strategies were better than active strategies at consistent returns in line with the underlying asset classes invested in. Do you think that a better understanding of the risk and return associated with asset classes would make it easier for your clients to ‘stay the course’ on their portfolios through market volatility? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.
