The price of active management
In the current environment of low and/or negative investment returns from equity funds, investors’ attention is once again focused on the issue of costs. This tends to reignite the age-old debate of passive versus active investment strategies.
The effect of investment fees on the total return achieved over a long term makes a staggering difference to the final proceeds accumulated,” says Dr Prieur du Plessis, Plexus group chairman. Du Plessis was commenting on a Plexus comparison of the effects of annual management fees of 0%, 1%, 2% and 3% on a R100 000 investment over 20 years at an assumed 15% annual growth rate.
“Where no fees are charged, an investment value of R1 636 654 is achieved,” says Du Plessis. “Where 1%, 2% and 3% are charged, the investment values attained are R1 374 349, R1 152 309 and R964 629 respectively.”
Applying the 3% annual management fee in the above assumption, the investor sacrifices R672 025 of the final proceeds on fees. In effect the investor receives only 59% of the potential value of the R100 000 investment. Likewise, the investor paying a 2% fee receives 70% of the potential value, while the investor paying 1% gets 84% of the potential value.
Collective investment schemes publish their Total Expense Ratios (TERs), which indicate the total expenses deducted annually from a fund’s assets. The latest average TER for retail domestic equity funds is 1,6%. “This means active managers on average have to outperform the FTSE/JSE All Share Index by 1,6% just to match the return from the index,” says Du Plessis.
He says a further study of the returns achieved by domestic equity funds - namely general equity, value and growth funds - shows that outperforming the FTSE/JSE All Share Index is no easy task. “On average, actively managed funds have not succeeded in outperforming the index over the past five or 10 years ended 31 May 2009. Furthermore, a mere 16,7% outperformed the index over the five-year period and only 30,3% outperformed over 10 years.”
“One could conclude that a passive investment strategy of investing in index trackers is the right way to go,” says Du Plessis. However, he says it is not so simple.
“There are active managers who consistently outperform passive indices such as the All Share Index over the longer term. But it is not always easy to identify future outperformers when looking at historical figures. One should also be aware that different managers tend to outperform or underperform in different markets,” says Du Plessis.
He says it thus makes better sense to include both active and passive investment strategies in an investment portfolio. “Investors should consider passive index trackers that are constructed according to the relatively new methodology that focuses on company fundamentals, rather than the traditional market cap methodology. There is more than sufficient evidence that index trackers utilising this new methodology provide returns superior to those of the traditional market cap indices,” says Du Plessis.
