Focus on costs in retirement industry puts spotlight on passive investing
But how ready is the South African market – and is passive the only way to reduce costs and what effect will it have on returns?
Globally, we are operating in a low-return environment where real returns are becoming increasingly difficult to achieve and correct asset allocation and stock selection has become even more critical. With the likelihood of achieving future real returns as above the 5 to 6% range and the increased focus on the reduction of costs, the debate between active and passive is once again on the agenda.
Vuyo Nogantshi, Head of Institutional Business at Nedgroup Investments, says it is clear that passive investing is gaining popularity as a way for the industry to reduce costs.
“In this environment, people are looking at passive as a way to reduce costs. Active management has potentially been oversold in South Africa and I think it’s a positive thing that industry is looking at this now,” he says.
Nogantshi explains that the focus on reducing costs in the industry – and the cost paper recently released by Treasury has brought passive investing to the fore as an investment strategy.
According to Nogantshi, cost is a huge differentiator between active management and passive management. “Active managers believe markets are not efficient and they can exploit mispricings – so one is paying for the manager’s expertise and experience. Passive managers believe that the market is efficient and therefore one cannot beat the market. As a result, passive is significantly cheaper than active investing - sometime 10 times cheaper depending on the strategy,” he says.
Nogantshi says the South African market is highly developed and does provide a good environment for a passive investor. “It’s not a case of emerging markets being less efficient than developed. All markets can go through stages of efficiency and inefficiency. As such, the South African market has times when it’s efficient and times when it is very concentrated and inefficient.”
Local investors are buying into passive investing, according to his experience. “Trustees are definitely seeing what’s out there in terms of the papers from Treasury. In a low yield environment, a few percent savings in costs makes a big difference to a member and they are therefore displaying a growing interest in passive management,” he says.
However, Nogantshi says there is still room for active management as well, which has prompted the emergence of a combination of active and passive philosophies when selecting stocks.
“Both active and passive investing have their merits and they don’t need to be mutually exclusive. The point is that, regardless of whether investors choose an active or passive approach or a blend of the two - it has to be a part of a strategy and a long term strategy at that.”
“When one looks at the expected returns of active, there is the possibility that you get the index minus costs and still make an excess return – whereas with passive one can only achieve index minus costs. There are still significant risks in passive investing and investors should not make the decision to go passive lightly,” says Nogantshi.
He explains that with a passive investment strategy, investors effectively place themselves in the hands of another skills set – typically the fund manager in terms of how effectively the passive strategy can be implemented. “While passive asset selection is typically based on a robust model, in the current highly volatile environment, the risks of the models being wrong or inaccurate are considerable.”
However, stakeholders should not be fooled into believing that investment related costs are the only cost-reduction mechanism. Various factors from charging methods to the preservation behaviour of members can have significant impacts on the end result.
Nogantshi also believes that while costs are a justified focus for industry, it’s important not to be so driven by this that alpha is done away with completely.
