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Your equity fund has probably underperformed

And it’s not because of Naspers.
The market return has been generated by a very narrow selection of stocks. Picture: Shutterstock

For the 12 months to the end of June this year the FTSE/JSE All Share Index (Alsi) was up 15%. The average return from unit trusts in the South Africa equity general category for the same period was, however, just 7.9%.

In other words, the average fund manager delivered barely more than half of the return of the market.

Figures from Morningstar show that only 17 funds in the category beat the broad market benchmark over this period. Nine of those are passive funds. One hundred and forty eight, underperformed.

Even accepting that equity funds should not be judged on one-year numbers, these are pretty eye-catching statistics. This is particularly the case in the current low return environment.

South African investors have had to stomach relatively poor returns for the better part of four years. Yet, in a period when the market actually produced decent performance, most of them still didn’t see it because their fund managers didn’t capture it.

The Naspers argument

It might be easy to say that this is because of the Naspers effect. The tech giant, which now makes up more than 20% of the Alsi, gained close to 37% in this 12-month period. That is a substantial part of the market return.

Given that any fund manager employing proper risk management would not have 20% of their portfolio in any single stock, every active manager in the country is underweight Naspers. None of them would therefore have been able to get the full benefit of its rally.

That’s the simple explanation. It also happens to be incomplete.

If your fund manager tells you that they underperformed because of Naspers, they are not being completely honest. That is quite easily demonstrated by the table below, which shows the top 10 performing general equity funds for the 12 months to end June:

SA equity general fund performance to June 30, 2018
Fund 1 year return
Sygnia Divi Index Fund A 24.92%
Satrix Dividend Plus Index Fund A1 24.49%
Satrix Quality Index Fund A1 22.33%
Coreshares S&P SA Top 50 Fund A 22.00%
Prescient Equity Income Fund A1 18.50%
ClucasGray Equity Prescient Fund A1 18.45%
Satrix Rafi 40 Index Fund A1 18.21%
Old Mutual Rafi 40 Index Fund A 18.06%
Fairtree Smart Beta Prescient Fund A1 17.58%
Momentum Value Equity Fund A 17.55%
Category average 7.91%
FTSE/JSE All Share Index 15.02%

Source: Morningstar

Of the top five funds on that list, four have no exposure to Naspers at all. Only the Coreshares S&P Top 50 Fund holds the stock, and it caps its exposure at 10%.

Naspers is the biggest holding in the ClucasGray Equity Prescient Fund, but at only 7.5% of its portfolio. The Satrix and Old Mutual Rafi funds both down-weight Naspers to under 4.0%.

It is therefore quite apparent that Naspers is not the primary reason for the outperformance of these funds. That must come with the corollary that the stock is also therefore not the primary reason for the underperformance of any other fund.

So what’s the driver?

The most important factor contributing to returns over the last 12 months has actually been resource stocks. For the year to the end of June the FTSE/JSE Resources 10 Index gained 44.6%.

BHP Billiton was up over 55% during this period, Anglo American gained around 76%, and Sasol climbed 37%. Those are the three biggest resource counters on the local market.

For good measure, Exxaro’s share price was around 35% higher and Kumba Iron Ore jumped 67%. African Rainbow Minerals gained just under 21%.

It should therefore be no surprise that the top five holdings in the Sygnia and Satrix dividend funds are resource counters – African Rainbow Minerals, South32, Exxaro, BHP Billiton and Kumba. Similarly, because the Coreshares Top 50 fund caps the size of Naspers, it increases the weightings of BHP Billiton and Anglo American in its portfolio.

The Rafi funds are also overweight BHP Billiton and Sasol. The Prescient Equity Income Fund has Kumba, BHP Billiton and Anglo American in its top 10 holdings.

It is quite apparent that this has been the key factor in their outperformance. And it has been far more significant than their exposure to Naspers.

So your manager sucks, right?

While this does rebut the Naspers argument to a fair extent, it doesn’t negate the principle. Whether it’s Naspers or these few resource counters, the market return has still been generated by a very narrow selection of stocks.

If your fund manager held these, you would have been okay. If they didn’t, you have missed out.

What is apparent is that the majority of fund managers obviously didn’t hold these stocks, given the degree of underperformance over the past year. It might be easy to criticise them for this since missing the resources rally completely has cost investors a chunk of potential returns.

However, it’s more important is to understand why your fund manager didn’t hold these stocks. Can they provide good reasons, and demonstrate a sound philosophy behind that thinking?

If they can’t, it’s time to find another manager. If they can, that’s more important than missing the short-term performance in a handful of shares.

What really matters is whether the philosophy your fund manager is following delivers the outcomes you are looking for over the long term. That might mean short-term misses, but investing is all about the long game.



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Naspers being 20% of the benchmark is an issue but has a relatively simple solution:

We now have the capped Swix benchmark which caps Naspers exposure (and any other large share) to 10% weight (a weight that’s plausible for a fund manager to hold).

While no benchmark is perfect, this is surely more appropriate for the Naspers problem.

Obviously the average active manager underperformed the market – we know this from countless research as well as mathematically at least 50% must be below benchmark, that’s why it’s an average.

This is why active management will continue to be under huge pressure, and only a few deserve to survive for real performance. Unfortunately it seems those with the largest advertising base and incentivised brokers will thrive for now because many customers are no wiser to the maths.

Benchmark indices incur no cost, therefore more than 50% of equity managers should in theory underperform. Having done a lot of performance attribution it is my experience that your share return distribution is never normal but skewed to a few good picks so it is not an anomaly that index return were generated from a few stocks. Even an equally weighted portfolio will have a skewed return distribution profile.

Research has shown that Equity returns can be attributed to a few fundamental factors. Have exposure to those with a robust weighing process, you are more likely to outperform 80% of high management fee professionals on a regular basis.

Be careful with the use of the term “passive”. The ETFs which out-performed over the 12 months are factor based (dividend, momentum, quality, capped, ect) and hence are active. Passive investing refers to market cap weighted and no other constraints.
As an investor your portfolio will probably not be only 1 of the outperforming ETFs, but rather a collection with an asset allocation objective, and hence your performance will also be different to those of the quoted ETF’s.

I wonder how big a portion of MW’s advertising comes from the passive investment industry.

I still wait for the day when Patrick puts out an article on the counter argument against passive investing, in that the market is the result of decisions made by active managers. Less active management = poor price discovery = greater future volatility = higher cost of capital.

Passive investments are spelling the death of publicly listed investment. Investment professionals are simply not prepared anymore to give away their IP for free. Stock market valuations are made by active managers hence the weightings in indices are the result of the research time effort and money of active managers. Index providers and the passive managers get their portfolio constructiuon done for free by the best minds in the industry.

Shift not as pronounced in SA yet but talented investment professionals increasingly opt for the private equity space where they do not have competitors whose business model is build on using its intrnally produced intelectual property for free.

Mark my words the next bear market will be amplified tenfold by the wall of passive money.

Patrick and the MW team simply seems to ignore this reality.

I have actually written more than one article about the supposed risks of passive investing. I would, however, recommend that you watch the following video, which explains the reality:

So the reality comes from S&P who makes its living selling indices to tracker funds?

I suggest you go and read independent, academic research:

“By contrast, passive portfolio managers have scant interest in the idiosyncratic attributes of individual securities in an index. They do not devote resources to seeking out and using security-specific information relevant for valuing individual securities. In effect, they free-ride on the efforts of active investors in this regard. Hence, an increase in the share of passive portfolios might reduce the amount of information embedded in prices, and contribute to pricing inefficiency and the misallocation of capital.”

“Numerous academic studies across a range of equity markets have identified co-movement, price pressures and other trading effects as securities are added to a benchmark index (eg Barberis et al (2005), Kaul et al (2002), Claessens and Yafen (2013)). Discernible effects are evident when individual stocks are included in the S&P 500 index: their correlation with the index increases, trading volume jumps and bid-ask spreads narrow (Graph 3). Research lends support to the view that index inclusion effects reflect “non-fundamental” investor demand shocks (Pruitt and Wei (1989), Greenwood (2008), Claessens and Yafen (2013)).11 The most obvious reason is the correlated behaviour of passive investors tracking an index, compounded by the behaviour of active investors that benchmark against an index. For ETFs specifically, there is recent evidence that trading and arbitrage activity contributes to the co-movement of S&P 500 stocks (Da and Shive (2018), Leippold et al (2016)).”

@Notwarren Calm down please.

This is only a threat to active managers who constantly underperform and charge exuberant fees.

Are you one of them? Because your reaction indicates that you are.

No need to get personal. Play the ball not the man. Tell me where you disagree from me rather than insult me.

It cannot understand how this is such a difficult concept to get across. It has nothing to do with performing and underperforming managers. The market as a whole determines pricing – in which there will always be over and under performers.

What I am saying is that it is impossible for passive funds to determine the value of a company because it invests according weights determined by the valuation of companies.

The only reason passive funds are able to charge the low fees that they do is because they have a fraction of the cost base of active managers.

And no I am not a fund manager.

Just below the top stories there is “Sponsored by Investec Asset Management” section, is Invested a passive manager? No. Your argument is weak Notwarren, and not worthy of anything but derision.

What exactly about my argument is weak? Note my argument is not about sponsorship. My argument is that less active money makes the market and its price discovery function weaker.

Which will offer more opportunity for the active investor then, so your problem is? 😉

Problem is twofold. 1) Worse price discovery = higher cost of capital = lower valuations and lower returns for investors + it means it is more expensive for firms to raise money. 2) The economics for running an active management house makes no sense. Passive managers carry none of the cost yet they sell the product you and other active managers produce – the market. Large global fund managers are catching on and moving resources to private equity.

Passive investment is a massive systemic risk. There is an inherent gearing and multiplier effect that we do not understand yet. Same as the instruments of the previous crisis only even more powerful. Facebooks 20perc drop today is a perfect illustration of this.

Will it eventually lead to the return of active management? Possibly, but people will lose a lot of money before that happens. It is going to be brutal.

You can blame the active managers for that (will you though, cause you love them?). Taking fees even if they perform poorly against their peers. Poor performers and their fees pushing people to index fund where at least the people know they will get the market average for their fees and not non-performance.


Yep! Imagine if most of the free float holders got religion and went ETF, leaving say 20% active. Anything the 20% does HAS to be followed. Imagine the scope for maninuplation when you know that you can start a small momentum that will be followed by a 4x momentum, into which you trade.

IMO the big ETF like SPY on the S&P or such in US is a classic for somebody (even a fun damager), that can not possibly try and cover global in any rational manner. SPY has a 0.09% expense ratio. Basically that is less the buy/sell spread on most stocks or definitely more than the rand dollar buy sell spread.

Absolutely. It is leverage and liquidity all over again just like the previous downturn. Any move made by active money must be followed by passive money. Till now its been all hunky dory because markets have only been going up but the opposite also holds true. Facebooks 20point drop today just speaks to the multiplier effect of passive funds. Add lack of liquidity to the mix once we get back to normalised monetory policy…It is going to be brutal.

My argument is also not that passive investment is a bad investment currently. On the contrary it is almost a no brainer as you point out. It is the equivalent of buying a suit without having to pay for the material used to make the suit. Passive managers gets its inputs for free so they will always outperform active managers.

My argument is that this is unsustainable and will pose significant systemic risk down the line. No rational fund manager will want to compete against passibe funds anymore. The economics dont add up. Every active market participant that leaves means the market becomes less efficient.

Is there any evidence to support the contention that “passive” has had an effect on price discovery?

‘’If all economists were laid end to end, they would not reach a conclusion’’

Bernard Shaw (1856-1950)

Definition of a fund manager:
A fund manager is someone whose job involves investing the money contained in a fund, for example, a mutual fund, on behalf of another person or organization.
Methinks most of our ‘’very well qualified’’ fund managers are no more than ‘’screen watching junkies’’, who underperforms!
My old colleague, friend and mentor – Dr Frank Shostak, founder of Econometrics (Pty) Limited, always used to call these types of underperformers, ‘’educated idiots’’!

End of comments.





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