The blurring line
It is time to step away from the word ‘passive’ in passive investment management and accept that all investment strategies depend on dozens of active investment decisions. This view emerged during a panel discussion at the 2020 Investment Forum, held in Cape Town in March 2020. The panellists, who presented in-camera following the event’s quarantine due to COVID-19, were tasked with answering whether the active versus passive debate missed the mark?
Panel chair, Eugene Visagie, a portfolio specialist at Morningstar, kicked off proceedings by asking whether passive investment strategies afforded investors greater protection during periods of market volatility. Kingsley Williams, Chief Investment Officer at Satrix said that such strategies generally had a greater potential to protect investors because the derivative products used to achieve such protection were better-aligned with the indices that passive investments track. The remaining panellists agreed; but warned that actual experience would vary based on the indices (and asset classes) covered by the passive solution.
Market corrections are inevitable
At their simplest, passive funds track an equity-only index such as the local JSE All Share Index or US S&P 500 Index. “The first point to make about investing in the equity markets is to understand the risk”, said Williams. “The return premium from investing in equities comes with a prominent health warning, namely that major corrections happen periodically”. He reminded delegates that the JSE All Share Index had achieved 7% real annual returns over the last 25 years (to end-2019) despite suffering three major stock market contractions over that time.
Nowadays investors can choose from countless passive funds that are issued as exchange traded funds (ETFs) or collective investment schemes (unit trusts). These funds often employ multi-asset strategies to diversify investors’ risks. “Passive investing now involves active decisions – and you need to be cognisant of the underlying indices you are investing in,” said Len Jordaan, Head of Distribution, Exchange Traded Funds at Absa Corporate and Investment Banking. He added that the proliferation of indices within the passive investment space contributed to investor confusion and further blurred the line between active and passive.
“As much as 90% of your investment return is driven by asset allocation which means that the asset allocation decision cannot be passive,” said Kyle Hulett, Head of Asset Allocation at Sygnia. “We are moving beyond the active versus passive debate to one of how to blend these strategies to get the best solution for your client’s needs and liabilities”. The panel agreed with his assertion that an investor’s time horizon was among the main drivers of long term asset allocation decisions. “Time [in the market] diversifies risk because if you go out long enough the volatility on various asset classes diminishes,” he said. Sygnia employs a Robo-adviser to assist clients in make their asset allocation decision. It makes fund suggestions based on a risk profile, risk tolerance and time horizon profile that is determined by the client’s response to 12 questions.
From passive to rules-based
One suggestion that emerged from the discussion was to reclassify passive investment as rules-based investment. “It is time to move away from the notion that there is such a thing as passive investing, all investing requires numerous active decisions even if the end decision is to track a broad market cap weighted index”, said Williams. In this environment financial adviser prove their worth by assisting their clients to choose rules-based investments that achieve the desired market outcomes in line with their risk tolerance and time horizons. “The biggest value that financial advisers can give their clients is to help them understand the risk in the product they are investing in, be it active or passive, by considering the holdings in the portfolio and understanding the macro environment impact on those indices,” said Jordaan.
This fits in nicely with the redefinition of risk from that of ‘market volatility’ to ‘the uncertainty of reaching an investment goal’. “This uncertainty centres on time frames and risk profiles,” said Gareth Stobie, Managing Director at CoreShares. He added that the CoreShares multi-asset funds adopted a strategic asset allocation framework. “We set two return targets and then consider how likely we are to hit those objectives given the asset classes and their long term return profiles – we then seek to give clients predictability around their outcomes,” he said.
Absa tackled the asset allocation question by considering two suites of product. The first suite, which offers a Growth and Moderate option, applies a fixed strategic allocation to equities, bonds, inflation-linked bonds and cash with the fund rebalanced to that allocation quarterly. The second suite allocates between equities and cash based on the relationship between market volatility and equity returns, offering three funds for investors with Defensive, Moderate and High Growth risk profiles. “This product suite fits into the passive space in that it is entirely rules-based, we have no discretion in terms of how we manage the portfolios,” said Jordaan. He observed that investors in their Moderate ‘target volatility’ fund had avoided almost 20% of the recent market contraction.
Myth-busting domestic investments
The panel agreed that South Africa was behind the United States and other developed markets in the uptake of passive investments; but they dismissed the myth that the country’s small, highly concentrated market made such products unsuitable. Instead they celebrated passive funds as a low cost investment vehicle that removes emotion-based responses from the investment debate. “One of the biggest advantages of rules-based investment is that the investor knows what they are investing in, they know exactly what they are getting exposure to,” concluded Visagie.
Writer’s thoughts:
The panellists at the 2020 Investor Forum agree that the descriptor ‘passive’ is losing relevance in a modern asset management context. This is partly due to the complexity of global financial markets and the sheer number of indices that both passive (in the traditional sense) and active asset managers can use to structure their fund solutions. Would you support a redefinition of the asset management universe into one of ‘active-passive’ and ‘active’ or should we simply stick with ‘passive’ and ‘active’ and accept that even ‘passive’ strategies require countless ‘active’ asset management decisions? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts editor@fanews.co.za.
