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Year to date, the best equity manager is the index

The Naspers influence has been immense.

Up until the start of June this year, the JSE was basically flat over the past three years. South African equity fund managers had very little to cheer them up over this period.

However, over the last three months the local market has enjoyed something of a revival. Since hitting a bottom on June 6, the All Share Index has climbed over 13% and is now trading at record highs.

As the below figures from Morningstar show, the funds that have benefited the most from this short-term surge are those tracking momentum indices.

Top South African equity funds for the 3 months to October 6 2017
Fund 3 month return
Ashburton Momentum SA Tracker Fund A 16.49%
Momentum Trending Equity Fund A 14.13%
Momentum MoM Emerging Manager Growth Fund F1 13.92%
Satrix Momentum Index Fund A1 13.73%
Methodical Equity Prescient Fund A1 12.68%
Stanlib Sector Neutral Momentum Index Fund A1 12.45%

Source: Morningstar

Note: Not all of these funds are available to retail investors.

These momentum indices essentially include stocks that are showing the biggest positive short-term price movements. In sharp market upturns, they can therefore capture some very quick, very large gains.

Looking over the slightly longer term, however, the top funds so far this year have been those tracking the FTSE/JSE Top 40 Index. As the table below shows, only one active manager is ahead of a pack of passive funds.

Even that is an anomaly though, as the Lion of Africa MET Equity Fund is currently being wound up. Its performance is therefore not really a true reflection, as its current portfolio is 100% cash.

Top South African equity funds for the YTD months to October 6 2017
Fund Year to date return
Lion of Africa MET Equity Fund A 26.00%
Prescient Equity Top 40 Fund A1 18.94%
Stanlib ALSI 40 Fund A 18.92%
Satrix Top 40 Index Fund A1 18.68%
Momentum Top 40 Index Fund A 18.67%
Sygnia Top 40 Index Fund A 18.57%
Momentum MoM Emerging Manager Growth Fund F1 18.44%
Old Mutual Top 40 Index Fund A 18.37%
Kagiso Top 40 Tracker Fund 18.28%
Ashburton Low Beta SA Composite Tracker Fund A 18.19%

Source: Morningstar

This performance from Top 40 trackers should not, however, be seen so much as a case for passive over active, as what can happen when one stock dominates an index. Naspers is currently around 21% of the Top 40, which means that its influence is immense.

The media giant has gained 59% this year, which accounts for easily the bulk of the gains in the Top 40. Active managers will almost inevitably underperform this index over a period like this as it is very difficult, and arguably not prudent, for any of them to take such a large position in a single company.

This has become one of the biggest criticisms of local index funds. They are now exposing investors to very high single stock risk. At the moment it is obviously to their benefit, but what happens when Naspers, which is now trading on a price-to-earnings ratio of around 130, goes the other way?

This is why even the majority of managers who are bullish on Naspers carry what is effectively an underweight position in the stock, relative to the index. The Coronation Top 20 Fund, which would be the next highest active fund on the above performance list, holds 16.5% of its portfolio in Naspers, and that is in a highly concentrated portfolio.

Investors therefore need to carefully consider their exposure to local index funds. Clearly there is a place for them, and they have done exceptionally well, but the argument for diversification is becoming increasingly strong.

To manage risk and have a more balanced portfolio, investors should think of combining index funds with funds run by high conviction active managers who build portfolios that look very different to the index. That offers them the best of both worlds.

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Well done!

I see Investec and Allan Gray are conspicuous by their absence, so far!

Well yes they are active managers. That is the point of this article. Passive index trackers are outperforming active managers due to it 20% weight towards Naspers. Active managers will hardly if ever have such a large weight to one company, because this negates any diversification benefit.

If you would ask most people if they would put 20% of their life savings into a fund investing in Chinese Tech companies I think most people, rightly or wrongly, would be too risk averse to do so. Yet this is exactly the advice that the financial press mostly give to investors in its relentless drive to promote passive investing. Worse it is essentially advocating a 20% allocation to one company.

Don’t worry, they will still charge a huge fee!

Or maybe methinks, Investec are preparing to be interviewed by Nhlamu Dlomu, with her MA in Clinical Psychology and experience in HR, who was appointed KPMG chief executive officer of the Johannesburg-based operations last month.
She must have by now noticed that KPMG milked JCI (the thief) and Randgold (the victim) for R 66 million for audits at both, but failed to pick up the thousands of shares by Brett Kebble!

Take Naspers, ABinBev and BAT out of our market and we’re running on empty.
It’s abnormal for a market to be that heavily dependant on the movement of so few shares.

That said, global sentiment towards tech stocks is positive, and looks set to remain so for a while to come, with many traders taking a bet on the future, today.
FAANG stocks, Tesla etc seen as pioneers of tomorrow’s world, so I wouldn’t bet against Naspers/Tencent yet, and I reckon that’s the position many fund managers are taking.

Expect indexes to run even harder, not yet time to panic, but of course, as is always the case, be prudent, it’s your money after all.

Active fund managers will soon find themselves irrelevant…

Could you please explain how valuation of companies will take place in such an environment? Why will Naspers trade at a 100x PE and Standard Bank at a 10x PE in your universe where portfolios are just made up on the basis of its weighting in an index? Will those weights remain static in your hypothetical environment?

People actually need to think these things through properly. The more active managers in a market the better price discovery and valuation takes place over time which leads to lower cost of capital which equals higher share prices. We will obviously never migrate to an environment with no active managers but reducing the number leads to less efficient valuation and these valuations just gets reinforced by the inflows into passive funds. Watch this space next financial crisis will be driven by passive investments. Logic dictates that you actually need a human with some level of intelligence to decide company A is worth more than company B.

There are many different types of passive indexes including the RAFI-type index which buys according to fundamental values of companies.

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