Sail to paradise in rough seas

Studies indicate that passive - or indexed - funds often outperform active funds (after taxes and fees), irrespective of market direction.

Although markets remain inefficient and unpredictable, stocks tend to offer the prospect of good returns over the longer term, with passive investors more likely to participate in these enhanced returns.

Good performers

Passive funds performing well in bull markets, but underperforming in bear market conditions, has been the topic of lively debate for some time. This aside, however, passive investing does offer the benefit of improved efficiencies in inefficient markets as index funds allow investors to track different markets and facilitate a more reliable, transparent and consistent (although not guaranteed) portfolio construction process.

The investment process should also, importantly, be determined by which approach – active, passive, or a combination of both - will best address the client’s investment objective.

Difficult navigation

In a still-stuttering global economy, which persists despite global central bank economic stimulus measures, inefficient markets remain difficult to navigate from an investments perspective.

Passive investing is effective in the current uncertain global market environment as a means, for example, to access alternative asset classes, like commodities and real estate, or in less mature economies like emerging markets. The use of indexed products is a simple solution that facilitates efficient access to essential diversification opportunities.

Bespoke benefit

Bespoke solutions, which can be customised in accordance with the beta of the underlying market, are also supported by this investment approach as they can be supplemented with an active overlay in terms of asset class, weighting and benchmark selection.

The desired payoff profile can be tailored to meet a diverse range of circumstances by focusing on the index construction and its risk-mitigating properties in order to deliver superior risk-adjusted returns in a cost effective manner.

Mechanical stimuli

Another positive of indexation is its ability to provide a mechanism to construct portfolios to obtain exposure to a particular investment style or factor, or combination thereof.

Past winners tend to be future winners, and past losers tend to continue underperforming during consecutive periods. Indexed products reflect the collective wisdom and performance insight of all market participants.

The range of asset classes available to achieve an optimal diversified portfolio solution continues to expand. Multi-asset class funds have increased their exposure to these new investment options. But, in most instances, the allocation remains significantly lower than those of traditional asset classes.

Index solutions are often preferred by both fund managers and investors as entry points for smaller allocations as a means to obtain affordable and representative exposure to new, and often less researched, markets.

Enter a new universe

Tracker products, in addition, afford investors access to the full universe of stocks in a market, whereas active managers tend to work within a more limited subset thereof, thereby reducing possible ‘investor psychology’ and exposure risk.

Index tracking exchange traded funds (ETFs) have become very popular and are also attracting interest from institutional and retail investors as index costs continue to decline.

Foreign investment in South Africa is creating improved liquidity and, as a result, increased competitiveness. This means that lower-cost investment solutions, like index funds, are becoming more sought after.

As South Africa evolves into a more efficient market structure, asset managers need to focus on providing a more client-centric investment solution. Client education in terms of investment options aimed at protecting savings need to form an integral part of the portfolio construction process and should ultimately drive the solution.

Indexed products offer a safer, affordable and more predictable investment option and make sense within the context of current market inefficiencies.