IN THE debate over whether an active or passive investment approach is best, it is comforting that neither side approaches the subject with the zeal of a fanatic. Pragmatism is an invaluable trait in investment professionals charged with managing investors’ money.
Any attempt to settle this debate leads to a stalemate.
Fund and portfolio managers are tied to their approach with a conviction that their investment choices are in a client’s interests. But their pragmatism allows them to acknowledge that the opposing view has merit.
And therein lies the answer: any investment choice is based on an investor’s circumstances, objectives and appetite for risk.
Investors Monthly has polled the opinions of leading investment professionals from the opposing active and passive philosophies to gather their thoughts and insights. These views provide some common ground that allows opponents to avoid any loss of face.
Given current market conditions of uncertainty and volatility and lower expected returns, here is what fund and portfolio managers have to say.
The active investment argument
• Jacques Plaut, portfolio manager at Allan Gray
"There are good arguments on either side of the debate. For the man on the street, the worst thing he can do is to be with a poor manager that underperforms over the long term, while paying fat fees. But if you’re with a manager earning his fee by delivering returns, that is better than being in a passive fund.
"On the whole, it is a good idea for investors to question the value for money they are getting for their fees. I’ve seen savings products sold by the big insurers with total expense ratios of 3% (before performance fees) — the odds are stacked against savers who are in these products.
"I’m not sure if a passive investment is a safer route. What often happens in this passive vs active debate is that investors tend to look at the previous year’s returns. The problem is that if you look back over a short period of time, you miss the impact of big events like the 2008 crisis or the 1998 tech stock bubble.
"As an active manager we hope to sidestep those extreme events that can take a big chunk out of your returns. If we can do that two or three times in a savings lifetime we will earn our fee as an active manager.
"In the current environment we do see some risk in that returns are low and people are more willing to take on higher risk to eke out better returns. The outcome is only going to be 100% clear with hindsight. I believe an active manager could be more cautious by avoiding those companies or bonds in which people are taking a lot of risk for meagre returns."
• Pieter Koekemoer — head of personal investments at Coronation
"By far the most important decision that individual investors need to make is their overall strategic asset allocation, deploying an appropriate risk budget in line with their needs and time horizon. And whether they are going to outsource this decision, and to whom.
"In the long run, asset allocation is going to be the biggest determinant of the outcome because the level of exposure to riskier assets is likely to give a greater return.
"The passive approach may be credible for asset-class-specific exposure, but it doesn’t provide a credible answer to the asset class decision. Typically, a purely passive approach to asset allocation will rely heavily on historical information, which is often not a good predictor of future market behaviour. An active approach that aims to incorporate current valuation levels and new market developments is more prudent.
"The biggest problem for the typical investor trying to achieve decent outcomes in an active portfolio is the difficulty of overcoming the urge to act if something goes wrong in the market or in the short-term returns of the portfolio.
"We clearly believe that active management can add significant value over time, but you have to be able to stay the course through periods of underperformance. The impact of poor timing decisions can be so great that it is better to be in a passive market tracking investment if it makes it easier for you to stick to that investment rather than chasing past winners when selecting active managers or asset classes."
• Greg Hopkins, chief investment officer, PSG Asset Management
"The arguments for passive are relatively simple: the universe of potential opportunities means the average manager will perform in line with the benchmark — though the average manager actually underperforms the benchmark because of the higher fees that are charged for an active strategy.
"In SA, certain fund managers have consistently outperformed passive on an after-costs basis. The characteristics of these managers include a consistent process, a long-term orientation and a value-based approach of trying to buy when expectations are low and sell when expectations are high.
"We think that differentiates us from numerous other asset managers and has resulted in long-term performance higher than the benchmarks. We believe the active approach can be a lower-risk strategy if you have a valuation approach because you’re avoiding overpriced shares.
"There is empirical evidence that active management in the fixed income space has returned good alpha. This is because there are more anomalies that create opportunities to exploit.
"There is also evidence that people are living longer, so they would want to have some growth assets in a portfolio over a longer period of time.
"Globally there are a larger number of ETFs that have come onto the market, many with a narrow theme-based strategy. I would caution against investors adopting these as a strategy as there is often the temptation to pile into ‘hot’ ETFs because they appear to be appropriate when they might not be suitable. The risk could be quite high because you could be investing in overvalued strategies."
The "both have a place" argument
• Philip Bradford, head of fund management at Sasfin Wealth
"I have been involved in both to an extent as I use active and passive investments to manage our balanced portfolio for asset allocation and single asset classes. I find passive, particularly ETFs, useful to get exposure to certain asset classes cheaply and easily. The invention of passive has allowed me to be more effective and cost-effective for our clients.
"For example, I use ETFs to get very quick exposure to something like the MCSI index, which contains more than 1,500 global blue chip stocks. It would cost a lot more to get that exposure by traditional means.
"The line between active and passive has become blurred. Active is easy to define. However the opposite of active is not necessarily passive: there are now many types of passive investment that are actually similar to active. The major criticism of active funds is that they are too costly and tend to underperform the index. However, many forget that a passive investment is guaranteed to underperform its index after costs.
"The debate is no longer active on the one side and passive on the other — they are not opposed any more. The key thing is cost, because the one way to guarantee performance is to reduce costs. This is the main advantage of passive, but as the old Afrikaans saying goes: goedkoop is duurkoop, if it doesn’t deliver the goods.
"Passive, for me, is best suited for institutional investors. It can be effective for individuals who want to get some exposure to the market, but it has to be seen in the context of their overall portfolio. It has to be seen as an instrument, not a solution."
• Grant Watson, co-head of customised solutions boutique at Old Mutual
"We have moved away from the hard-sell of specific products or funds to having a conversation with our clients — whether individuals, institutions or pension funds — to find out what they’re trying to achieve.
"We use our indexation funds in the passive investment space, which range from pure index trackers to customised smart beta type offerings, in conjunction with our active funds (and with protective overlays if required) to achieve customised objectives. So we may have a client who wants exposure to a particular region or sector and we can build that solution for them.
"I wouldn’t favour one approach over the other. Passive investments don’t offer any risk protection, but can be combined with lower risk, actively managed equity portfolios to deliver a lower cost and lower risk outcome. This gives investors the best of both worlds.
"For us it is not about an active or passive approach: it is about blending different solutions and about how you achieve your investment objectives. We believe there is space for both (active and passive) and that indexation is appropriate if you want certainty and lower costs."
The passive debate
• Helena Conradie, CEO of Satrix
"We grew up in an active house, so in a way we understand both worlds and believe in both approaches. How you blend them is more important than choosing between active or passive.
"In the end it amounts to making a well-informed choice. The biggest mistake you can make is to not be aware of all the options available.
"It is also important to recognise that although there are active and skilful managers to be found in the South African market, they are rare. It is dangerous to simply pick the latest trend; one has to focus on the long term and not be lured into switching too quickly.
"The debate has moved on, and the new challenge is how to use these building blocks to construct a more diversified, smart portfolio.
"Fees will contribute to one’s decision, but that is not the overriding factor in the construction of a portfolio — risk should be. The systematic approach to passive investing lends itself towards portfolio construction and risk analysis, whereas the nature of active management will always result in a couple of unknown drivers of risk and return. The challenge is to construct a smarter, more diversified portfolio by blending the two approaches.
"A lot of people think that passive is less risky; that is not necessarily the case. You are still exposed to the same risk, ie the market. You are just able to explain the risk in a more precise manner.
• Charles Savage, CEO of Purple Group
"My view is informed by the fact that 80% of active managers underperform the benchmarks they set out to achieve. This alone makes a strong case for ETFs.
"For investors who find themselves invested in an underperforming fund, the obvious and easy alternative is to move to the ETF that represents that benchmark. In so doing they will have a positive pick-up in performance while reducing their investment costs, further boosting returns.
"In my view the primary appeal of ETFs is that they offer easy access to index or sector performance at a low cost, and while there are other benefits like diversification, these are the primary benefits. Achieving benchmark performance, however, is like attaining the average exam result from a class of students, in this case share returns from a sector or index.
"The key question the investor needs to ask is this: will the average return from a set of stocks be enough to achieve my investment goals? It is my experience that nine out of 10 times the answer is simply no. Typically South Africans start investing too late and with too little and so they cannot afford average returns but need to seek out benchmark-beating returns. It is at this point that the passive vs active debate becomes more interesting and the case for active management is stronger.
"Over one, three, five and 10 years, if you compare the benchmark returns against the returns of the top 10 active unit trust managers, you will note that the case for seeking out better than average returns is strongly supported by the fact that, in many cases, these top 10 managers have been able to outstrip their benchmarks several times and in so doing improve their clients’ chances of attaining their investing goals.
"The good news is that finding the best active manager is not difficult, because the industry ranks them every year and top performers are rightly not shy to talk about their performance.
"For me, the real issue is that being disciplined about where your money is invested is more important than the debate about active vs passive as each has a strong role to play. So, if you are in a low-performing investment it makes sense to move swiftly into an equivalent ETF. This is an easy move, if you like, and it will immediately positively impact on your costs and performance."
• Wehmeyer Ferreira, head of DB X-Trackers SA for Deutsche Bank
"All our ETFs reference offshore markets, and are purely passive.
"The general benefits of passive are that there are no to low tracking errors, they are predictable and they offer lower costs, which over the long term don’t erode future returns. ETFs are also easy to understand.
"Where our products have an added benefit is that the complexity around investing offshore from SA is removed. They also provide geographical diversification from the SA market, which is dependent on commodity prices and global growth. Apart from the country diversification, these trackers provide diversification into sectors that are quite limited in local stocks.
"These are, however, still equity-linked products, which demands a higher risk profile as an index can still go down. But, if you’re comfortable with the offshore market you buy in through the ETF, you generally know what you’re in for."