CAPE TOWN – Index investing in South Africa is still some way behind that in developed markets like the US, but it is undoubtedly gaining widespread recognition. More investors and advisors are seeing the value of using passive products in their portfolios.
The debate around the use of these products has moved a long way from when it was viewed as an either/or question between using active or passive managers. There is a greater understanding of their relative benefits.
At the Momentum Investment Summit in Cape Town on Thursday, the CEO of Satrix, Helena Conradie, noted that there has been a significant shift in how these products are viewed.
“Fifteen years ago, passive was not even on the radar,” Conradie said. “But now the idea is definitely mainstream even if the flow of funds is not mainstream yet.”
She said that the biggest hurdle that passive providers need to overcome is the assumptions that investors still have about indexing, such as that passive is average or that South Africa is too small a market for passive to work effectively. There is also a view that big brand active managers outperform and continually outperform.
However, as Anthony Ginsberg the MD of GinsGlobal pointed out, few very active equity managers outperform the index, whether that is in the US markets, European markets, global markets or on the JSE.
“It’s not because active fund managers are stupid or doing a bad job,” he said. “The reason they underperform is because they churn their portfolios to such an extent that the brokerage costs, the commissions, the charges can add up to another 100 basis points to their costs that are not reflected in the total expense ratios (TERs).”
In essence, active managers are starting on the back foot. Even though there has been some criticism that passive products in South Africa are not as cheap as in international markets, they are still significantly cheaper than active alternatives.
“If there is an 80 basis point differential between what the active manager is charging and what a passive manager is charging, the active manager is starting with that handicap,” said Gareth Stobie, MD of CoreShares. “And they have to make that up year after year.”
This advantage is what is driving the uptake of passive products in many parts of the world. Already around 40% of money in equity mandates in the US is in index products and passive inflows are far outpacing those into active funds.
There is also the growing realisation that although there will always be some active managers who generate above market returns, it is very difficult for investors to identify them beforehand. Those that do well one year are not necessarily the same managers that do well the following year.
“There are definitely skilled active managers in South Africa, but the challenge is how to choose them before they outperform,” Conradie said. “If you managed to pick the best five managers every year for the last 20 years you would have had to make 80 changes over that time. That is the challenge that the investor or financial adviser has.”
Ginsberg said that this has become a major reason for indexing becoming mainstream in the US.
“Financial advisers have gravitated from trying to find the next hotshot fund manager who is going to beat the market to building portfolios around a basic core index using passive funds,” he said. “Around that they put satellite funds with specialist exposures like small caps or emerging markets or corporate bonds where they feel that they can add value.”
The realisation among investors and financial advisers in markets like the US is that passive products are very powerful tools in portfolio construction. It’s not about excluding active management, but using both active and passive most effectively.
“Advisers shouldn’t see passive as a threat, but as a tool,” Conradie said. “They need to think about how they use passive and active strategies together to create client specific solutions.”
Stobie said that advisers in South Africa need to see the growth in passive products as an opportunity to create more value for both their clients and themselves. Clients benefit from lower cost portfolios, more consistent performance and greater simplicity.
Advisers benefit because by bringing down the total cost of their service to clients they are able to maintain their margins. That will be increasingly important in light of the Retail Distribution Review (RDR).
“There is a lot more to a financial adviser’s value proposition than picking active managers, because frankly that’s a mug’s game,” said Stobie. “It is easier to sell those brands, but really their value proposition is much more than that.”