Engaging fund managers in the active versus passive debate
According to Steven Nathan, Chief Executive of 10X Investments, fund managers should have a fiduciary duty towards investors and therefore act in their best interests. In choosing between an active and a passive fund, it is a question of mathematics and probable outcomes, and both favor the passive approach.
“Because passive investors have abandoned the quest for alpha and simply pursue the market return at low cost, their forfeit is lower. They pocket a higher average return. In the words of Charles Ellis, they win the losers’ game. And it is a game worth winning: every 1% per annum fee saving over a forty-year savings term, improves the real (after-inflation) savings outcome by 30%,” he said.
Instead of offering multiple different products and alternatives, Nathan said managers should focus on providing simple, universal solutions that give investors a high chance of meeting the goals set in their plans.
At PSG’s Annual Conference, there was a discussion focused on issues around the active versus passive debate, equity funds versus flexible or multi-asset funds and offshore funds.
Alec Hogg, Journalist and key note speaker, facilitated a panel discussion with Greg Hopkins, PSG Asset Management Portfolio Manager and Chief Investment Officer, Peter Brooke, Head of Macro Solutions at Old Mutual and Duane Cable, Head of SA Equity at Coronation.
Deciphering the debate
According to Investopedia, actively managed funds build and maintain a portfolio by making deliberate decisions on securities to buy, sell or hold. Managers select securities from the universe of possibilities based on research and judgments on company fundamentals, economic trends and cycles for industries or asset classes. They generally seek to outperform a particular market index or strategy.
Passively managed funds seek to match the holdings and returns of a particular market index, such as the large-cap Standard & Poor’s 500 Index. Managers do not look into individual companies or securities; their primary philosophy is that markets are efficient, and therefore, an investment manager is not able to consistently outperform the market. If the index rises 10%, the fund value should grow about 10%; if the index falls 10%, the fund should drop to around 10%.
“Our market is incredibly concentrated which means the passive approach becomes a momentum strategy. The active versus passive debate is still flawed because you still have to choose, and that is one of the reasons why there is little penetration of passive into solution funds when mixing up different asset classes,” said Cable.
“In a conservative fund you will have a lot of fixed income. If you used a passive methodology, you would be spending more money where there is more debt and more risk of going bust. I am comfortable with passive investments, however, for the long-term I do not see it as a solution,” continued Cable.
Hopkins said the rewards for getting the debate right are significant. “If you can find the right active managers then the rewards are great. You have to look for managers who have a long-term approach and that have a fundamental value approach i.e buy low and sell high.”
Balancing the options
In the South African market, according to Cable, passive manager fess are still incredibly high but over time these fees will have to decrease to become better for clients.
“As active managers you have to do the opposite by looking for pockets of value where there is a difference between price for the asset, relative to the share price. There are enough successful long-term managers with track records that show it is possible in our market to outperform over meaningful periods,” said Cable.
Brooke mentioned that the benefit of a multi-asset class is the ability to move between the different asset classes which create your active asset location, which in turn creates your alpha.
Hopkins said it is easy to change returns but it is better to play a more defensive role then offensive role because you will get more opportunities to deploy your capital. He encouraged advisers to be disciplined, patient and cautious.
“These asset classes are often seen as being the low risk asset classes, but I think the risks are actually the highest in those lowest risk asset classes because they are significantly overvalued. So it is recommended that advisers remain cautious and patient,” added Cable.
Smart investing
Cable advised that it is not a time to start doubling up on equities. “It is all about the price you pay relative to the present value of the future cash flows for the investments that you buy. You need a margin of safety and at the moment the margin of safety in the market is not appropriate. Cautiously invest by not chasing performance and not overpaying for super high multiples for businesses that are trading on crazy evaluations. Rather be patient and wait for fat pitches, while looking for opportunities. For investors it is important to understand the approach of the manager and changing the approach to returns.”
Brooke further added that it is always about the strategy and what outcome you want for the client. “When you model that, depending on the risk return profile, you get simple answers. Then you consider two decisions; what is the view on assets and what will the real value of the rand do. It is a balance.”
“Look for high quality companies that are trading at reasonable valuations that are going to keep you in the game. Allocate a certain percentage of your portfolio with resources. In the long-term they will generate good returns,” continued Cable.
Nathan previously mentioned that advisers should eliminate complex products, provide fund transparency and eliminate biased financial advice. “It is a question of choosing the investment style that has the highest probable return over the investment time horizon. And that is a well-executed, low cost passive investment strategy.”
Editor’s Thoughts:
As Hopkins mentioned, the rewards for getting the debate right are significant. Be patient and cautious and invest in the right funds at the right time. The investment return gap and the alpha opportunity are the real ways to convince investors. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts [email protected].
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