Picture: 123RF/DOLGACHOV
Picture: 123RF/DOLGACHOV

If you have a higher-cost retirement annuity (RA) on which you are paying for active investment management, your provider or adviser is likely to defend it by saying the investments will deliver superior performance over time that will outweigh the higher costs.

Supporters of actively managed investments often point out that passive investments will always underperform the index they track.

They also point out the risks of investing in indices that are highly concentrated in a few large shares in SA, how indices buy high and sell low, and how bond indices lead you to buy into more government debt when debt levels are rising.

Passive investment providers, on the other hand, will tell you that very few active fund managers outperform common benchmarks and you can't predict which ones will. Fees, however, are certain, and saving on them therefore gives you certainty.

Active managers counter this by saying they should be measured against their individual benchmarks rather than a common one, and that performance is cyclical, resulting in periods when actively managed funds underperform and periods when they outperform.

Many investors fear they will lose out on the higher returns an active manager can deliver if they choose a cheaper passive option. In the same way that fees can compound over many years, so too can underperformance.

Illustration: NOLO MOIMA
Illustration: NOLO MOIMA

Brandon Zietsman, CEO and head of investments at discretionary investment manager Portfoliometrix, says an investment of R100 that earns 10% a year over 20 years will grow to R673. If you did 1% worse (the ravages of fees), you'd have 17% less wealth; if you did 1% better by using "a decent investment manager", you'd be 20% better off.

Zietsman says passive providers often imply active fees are a pure drag on performance, forgetting that fees are a cost of production. He says they have a point when they focus on the "average manager", saying the average is guaranteed to underperform the market over time.

But a good investment manager or discretionary investment manager does not invest the resources it does in pursuit of the average manager, he says.

While you as an ordinary investor only have a few performance measures to consider when choosing managers and the way to combine them, professional managers do much deeper research.

Discretionary investment managers unfortunately do not publish the performance of their portfolios, but if you are using a financial adviser, they should be able to show you a relevant track record.

When you consider that performance, look for longer-term returns in line with what you need - around inflation plus 5% or 6% after fees if you are saving for retirement that is more than five years away.

Your retirement investments should ideally be in a multi-asset or balanced fund that invests across equities, bonds, listed property and cash.

Investors with underlying unit trust fund investments can check the longer-term performance that is quoted after investment fees and costs and compare this to what passively managed multi-asset funds can achieve after costs.

Passively managed multi-asset funds in SA are growing and the first, the Nedgroup Core Diversified, now has a meaningful 10-year track record.

It has an annual average return of 10.46% over 10 years to the end of August, according to Morningstar, beating the return of the balanced funds of Allan Gray, Coronation, Foord, Old Mutual and PSG.

The fund is ranked 10th among 80 funds with a 10-year track record in the unit trust category for high-equity balanced funds that can invest up to 75% of the fund in equities.

It did not beat the popular Investec Opportunity Fund, with an average annual return over 10 years of 10.79% or the Prudential Balanced Fund with 10.7% a year.

The underlying passively managed investments in 10X's RA are in the 10X High Equity Portfolio, which also has a 10-year history, but the investments have been managed in a life portfolio making it difficult to compare to a unit trust.

The portfolio's annual performance over 10 years reported in the Alexander Forbes Global Manager Watch is 11.9% a year and 10X is ranked sixth against its peer managers. This return is, however, before fees.

There are eight passively managed balanced funds that have a five-year track record. The top performer among them is the Gryphon Prudential Fund of Funds with a return of 8.36% a year over the past five years to the end of August. It is ranked 10th out of all the balanced funds.

If you are invested in an RA where the underlying investments are managed by a discretionary manager like Portfoliometrix, you will also have a hard time finding comparable performance numbers because these managers do not publish this data.

The performance of Portfoliometrix's model portfolios on the Investec platform over seven years can, however, be compared with that of the Nedgroup Core Diversified Fund and the 10X portfolio, as reported on its website, minus the fees it charges in its new unit trust.

On this analysis Portfoliometrix's two portfolios outperform both 10X and Nedgroup Core Diversified by at least a percentage point each year after the investment management fees and discretionary manager fees. Over five years, the gap is wider.

Investment fees on a passively managed portfolio can be a full percentage point lower than those on an actively managed fund, but the Portfoliometrix example illustrates that you must weigh up the certain fee saving against the potential return advantage.

The Nedgroup Core Diversified Fund, for example, has a total investment fee of 0.55% when most large balanced funds have fees closer to 1.7%, according to Jannie Leach, head of core investments at Nedgroup Investments.

A discretionary manager may have a lower fee than an active manager as it may make use of some passive investments and may enjoy lower fees from large managers, but it will be higher than a passively managed fund.

Also, remember that some RA providers also drop their platform administration fee if you use their index-tracking investments.

Index-tracking investment do expose you to the risk of a severe drop in your investment value when the market turns south, but diversification in a multi-asset fund helps.

Leach says Nedgroup’s multi-asset funds shows that with good diversification across asset classes using sensible index-tracking strategies you can achieve not only above-average returns but any drop or drawdown will also be less severe than the average. Currently almost all the multi-asset funds – passive and active - have failed to achieve the inflation (4,92% for the past five years) plus five or six percent target over five years.

It is not possible to call the top-performing fund or combination of funds for your RA. You can only check if there is some consistency of above-average performance after fees over time.

Weighing up performance, Zietsman says he looks not only for consistency of performance, but returns earned each year in good and bad market conditions.

If you don’t feel capable of doing this and don’t want to pay for advice and particularly professional investment advice, a passive investment may well be your best bet.