It is time to put passive investing at the core

Is passive investing becoming mainstream in South Africa, and what are the perceived barriers to passive investments.

• “Advisers find it easier to pitch a known brand to investors.”
• “Very few active investment managers in the world consistently outperform the index.”
•  “40% of US equity portfolios are passively managed.”
• “Passive portfolios are a useful portfolio construction tool.”
•  “Adviser value propositions need to be more than just trying to pick the next hot investment manager.”

At the Momentum Investments Summit in Cape Town on 12 November, Alec Hogg, editor and publisher of Biznews.com chaired a panel discussion on whether passive investing is becoming mainstream in South Africa, and what the perceived barriers to passive investments are. 

The panel consisted of Anthony Ginsberg, managing director of GinsGlobal Index Funds, Gareth Stobie, managing director of CoreShares and Helena Conradie, chief executive officer of SATRIX. 

Conradie said that although the idea of passive investing is mainstream, the flow of investment is not as yet. She said a big obstacle is the current assumptions about passive investing such as passive investing is average, or “goedkoop is duurkoop”, or that the SA market is too small and too slanted towards commodities. 

There is also a tendency to favour big brands, as advisers find it easier to pitch a known brand to investors. In addition, there is a perception that active investment managers consistently outperform the market.   

However, Ginsberg pointed out that very few active investment managers in the world consistently outperform the index. He said investment managers underperform because they churn their portfolios and lose money by having to pay commissions and brokerage fees. This puts active investment managers at a distinct disadvantage. 

Stobie concurred, saying that although passive portfolios in SA are not as inexpensive as elsewhere in the world, they are still significantly cheaper than actively managed portfolios. He said that if an active investment manager charges 0.8% more than a passive investment manager, the passive portfolio has a head start and the active investment manager must make up that additional fee in returns year after year. This is what is driving the trend to passive portfolios worldwide. 

Ginsberg said that 40% of US equity portfolios are now passively managed. Advisers in the US are focusing on asset allocation, which research shows results in 90% of returns. They then use passive portfolios to execute their asset allocation strategy.   

Smart beta portfolios are also gaining traction in SA, as they move index investing from simple equity exposure to a specific outcome, such as a low volatility portfolio that tracks only low volatility shares. These passive portfolios can be used as a tool for constructing a portfolio that is outcomes orientated. 

Conradie said there are always skilled active investment managers that generate above-market returns in a particular given time period. The problem, she said, is choosing and investing in them before they outperform, and then disinvesting before they underperform. This is the dilemma the adviser faces: how to select the portfolios that will outperform the market year after year.

Conradie pointed out that if you managed to pick the best five investment managers every year, over a 20-year period you need to change investment managers 80 times. 

Ginsberg said advisers in the US have stopped trying to spot the next year’s top investment manager and instead are building portfolios around a passively managed core, with some satellite specialist portfolios to add a potential returns uptick like small caps, bonds and hedge funds.

Conradie said advisers should view passive portfolios as a useful portfolio construction tool rather than as a threat. Ultimately, advisers should use passive and active strategies together to create client-specific solutions. 

Stobie said that with the advent of the Retail Distribution Review (RDR) regulations in SA, advisers should consider passive portfolios, as these reduce the total cost to the client leaving a bigger margin for advisory fees. At the same time, clients benefit from lower-cost portfolios and less volatile returns. 

Stobie advised that although it is often easier to sell a big brand, adviser value propositions need to be more than just trying to pick the next hot investment manager.