Asset managers have more to offer than just the hope of “outperformance”.

Active management refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming a benchmark typically referred to as "beating the market”. The opposite of active management is called passive management, better known as "indexing" or "tracking”. The primary benefit of passive management is low fees and guaranteed market performance as opposed to the primary benefit of active management being the promise of "outperformance”.

 

Over the years, active management has come to dominate the SA market with investors willing to pay more for the hope of superior returns. Unfortunately, however, there is mounting evidence suggesting that the pursuit of outperformance is an endeavour where the probability of success is far too low for asset managers and investors alike.

 

In the US, even before fees, beating the market is still difficult. Charles D. Ellis, a consultant to large institutional investors, discussed the challenge that the profession faces in a 2011 article in the Financial Analysts Journal called "The Winner's Game". He noted that, "Most investors are not beating the market; the market is beating them. ... And it's much, much harder to beat the market after costs and fees." Ellis found that the percentage of mutual fund managers, who lag their relative index, after fees, is 60% in any one year, 70% over 10 years and 80% over 20 years.

 

Locally, the picture looks very similar. There are currently 108 domestic general equity funds with 5-year performance track records. It would be reasonable to assume that, over this period, the primary objective of the majority of these funds was to outperform the All Share index. However, an analysis of the funds’ returns reveals that only 20% managed to achieve this goal. The statistics are even worse for active property fund managers. Over the past 5 years only 1 actively-managed property fund has been able to outperform the South Africa Property Index.

 

Whereas twenty years ago, asset managers adopting an active management strategy had reasonable prospects of success, in today’s intensely competitive security markets, very few active managers consistently outperform. Consequently, the continued relevance of active management has been questioned with more and more investors settling for the "Index”.

 

With the odds stacked against outperformance does this mean that the passive route is the best way for investors to achieve their financial objectives? At Marriott we disagree. What is required, however, is an adaptation to the interpretation of the phrase "active management” to one that places the financial objectives of clients as the "benchmark”.

 

At Marriott, when managing our portfolios, we start by asking the question: "What does the client require?” We have to look first at the needs of investors, or groups of investors: Do they require a monthly income? If so, at what level? And do they require their income and capital to grow?

 

Once we have ascertained the clients’ needs, we are in a better position to satisfy them and we will construct a portfolio which seeks to address those needs rather than trying to outperform an index.

 

The first step in this process is to assess all available financial instruments in terms of client suitability. For example, if we look at the JSE All Share Index, we see that some 30% is comprised of resources stocks. For clients such as retired investors, who require a steady income stream, these investments are inappropriate as their dividends and capital values are notoriously volatile. The same could be said about companies which do not pay dividends or companies trading on very low dividend yields.

 

Having filtered the investable universe for suitable financial instruments, we then analyse – on an individual basis – the ability of those instruments to generate a consistent income stream and establish at what rate that income is likely to grow. With this information we are then able to determine a sensible price to pay for each investment – a price which will ensure an acceptable level of income and capital growth. The end result is a portfolio which will look nothing like an index but rather consist of investments best suited to the needs of a particular investor or group of investors.

 

By putting aside the desire to "outperform” and instead aligning the benchmarks of our portfolios with the financial objectives of investors we are able to increase the likelihood of our clients’ expectations being met. This we feel is the essence of active portfolio management.