Active vs passive: Thinking through what’s best for you
Investment management fees in SA have a good bit further to fall
There are powerful forces at play in the asset management industry that will ultimately benefit you, the investor.
Waves of consumerism and waves of regulation globally are driving competition and increasing transparency in the investment industry, which will ultimately lead to driving down investment fees for your benefit.
The hottest debate is over the use of low-cost index-tracking, or passive investments, or actively managed investments.
While we at Veritas do not advocate one investment approach to the exclusion of the other, declining fees across the board enable us to increase the probability that you, as a client, will achieve your lifestyle goals.
As independent advisers, we need to continually reassess how we implement the advice we give you and in a world of fake news, that means rolling up our sleeves and not just simply reading the headlines.
While the asset management industry wants to attract your money into their funds, it is our job to slow everything down and check if the players are in fact giving us credible information.
The importance of fees
The price that you pay for an investment is important.
The cheaper you can buy the fund the better your chances of achieving a better return. But is not the only consideration. If for some reason the underlying investment underperforms then it can have a knock-on effect on your lifestyle.
We have watched the international asset management market change dramatically over the past five years as regulators demand more transparency.
The rise in the use of passive investments has increased competition and driven down active managers’ prices significantly to where we are now seeing excellent managers charging only 0.6% a year in fees.
The smaller SA industry has reacted slowly and though fees have started to fall, the international experience shows they have a good bit further to fall.
Imagine the day when the gap in fees between passive and active investments has narrowed significantly. This will have a negative effect on the strongest passive argument, but passive investment providers will have been responsible for increasing the competition and noise to drive the fees down.
The message investors often pick up from the sound bites of low-cost investment providers is that all low-cost investments beat active managers.
This is simply not true. It is fake news to argue that “it’s not worth paying them that much” or “you won’t ever get a better return than the index”.
There are several active managers who do beat the low-cost passive managers over the long term, even with the high fees we now have to endure.
Passive investments globally and locally have had a perfect 10 years. Since the global crisis, there has been a run to what are being referred to as quality stocks. These are rock-solid companies that pay regular and strong dividends.
The valuations (prices relative to earnings) of these companies in the US have been driven to high levels. Close to half the assets in the US have been moved out of active management into passive since the 2008/09 financial crisis.
The sheer weight of money being thrown at these quality stocks has been spectacular, regardless of their valuation. Locally, low-cost passive investments have been less successful in attracting flows.
This is probably because the Naspers weighting was so big. But if Naspers is the reason so many investors stayed away from passive, it is precisely the reason that passive has done so well over the past 10 years.
Active managers believed they were being prudent by not owning that much Naspers (its index weighting is 19%), and their performance has suffered as a result.
Markets go through cycles and morph over time. The environment over the past decade has been conducive to passive funds and not helpful for value managers.
Twenty to 25 years ago Foord and Allan Gray were the only value managers and everyone else a growth manager. Value managers were at the bottom of any performance tables.
However, after the dot.com market implosion more asset management houses started to make investment decisions based more on the underlying value of shares than purely on considerations of growth.
Now, it is hard to find a growth manager in SA. It seems with the advent of passive funds the markets have changed, and passive became the new growth funds buying quality stocks locally.
Simultaneously, it has been tough going for value managers over the past five years.
How can there be so many poor active managers out there?
Anyone with a good business brain can see how much money can be made from asset management.
With many businesses controlling their own distribution (through tied agents) the money flows in strongly and regularly into their own funds. Advice is a loss leader and asset management is hugely profitable.
Fundhouse, an independent fund research and ratings house, estimates that 70%-75% of active managers in SA are not beating the relevant index and will be unlikely to do so in the future.
The fees they earn are just too profitable. This is where independent advice comes into play.
The answer in the end is that it is not a case of one or the other, it is probably a combination and knowing when a fee for potential outperformance is worth the bet and when paying the lowest fee is your best bet.