Passive balanced funds are in an interesting space as they benefit from two broad trends playing out in the retail investment market. Firstly, they are benefitting from the trend towards passive investments. Statistics show that global investors are now investing more in passive funds than active funds, particularly in the US.
Local investors have also increasingly turned to passive investments. Secondly, these funds are benefitting from the trend towards multi-asset funds, as investors have come to embrace the principle of diversification. Multi-asset funds (those which invest in a number of asset classes such as equities, bonds, cash and property – local and offshore) have grown from 24% of industry assets a decade ago to half of industry assets today.
Some passive product providers will have you believe that fees are the only thing that matters in investing. If you can reduce the fee that you pay then your returns will increase proportionally over time. An analysis of the performance of passive balanced funds allows us to park the fee debate and examine the relative performance. The graph below shows the performance of five passive balanced funds, which have at least a three-year track record.
The first observation over this period is that ALL these funds have outperformed the sector average. This reinforces the importance of fees in a low return environment. It is also a bit of an indictment on active managers who really should be delivering in these difficult markets as this is their value proposition. Balanced mandates give these managers sufficient space to showcase their skills, and justify the premium pricing.
The second observation is that there is a meaningful difference in performance between the best-performing fund over the period; Satrix Balanced, and the worst-performing fund; 10X High Equity. Satrix outperformed 10X by more than 2.50% per annum over the period, which is significantly higher than the fee differential between these funds. Satrix’s total investment charge is around 0.23% higher than that of 10X.
Key performance differentiators are the asset allocation strategy and the underlying indices, which these funds track. The table below shows the asset allocation of these funds as at December 31, 2018. Surprisingly Satrix and 10X have the highest equity exposures (local and offshore combined) but have performed the best and worst respectively. So investors have to dig a bit deeper when deciding which fund to use. Or do they?
The asset allocation of the funds raises a number of interesting issues. It seems as if they have been slow to respond to the higher offshore allocation that balanced funds are allowed. This was increased from 25% to 30% in last year’s budget. Prescient has a 3% exposure to alternatives although there is no such exposure included in the fund’s composite benchmark. That appears to be something of an active call although not much information is available in the fund’s MDD.
A performance review of those passive balanced funds with longer than a five year track record shows that these funds have managed to perform comfortably in the top half of the sector. This outperformance is a lot more pronounced over the longer measurement period. There are only three funds with more than a five-year track record, although the Prescient Balanced fund will pick up a five-year performance from May.
Satrix Balanced barely holds onto its top performing status with all the funds having lagged and led the pack at various stages over the period. This suggests that the spread in performance seen in the three-year review may in fact be temporary.
The growth in passive, multi-asset funds is likely to continue gaining traction in future. We expect this to become a much bigger part of the market especially if relative performance continues as per the last five years. Traditional active managers such as Absa, Alexander Forbes, Old Mutual and Stanlib are entering the space with their offerings. It will be interesting to see if they get the pricing right as this is a key factor for investors.
This growth is also likely to increase the pressure on active managers to up their game and lower their fees, especially if the outperformance persists. This is positive for long suffering investors who have been increasingly voicing their displeasure at investment results over the last three years. This frustration is compounded by managers charging performance fees for delivering less negative returns than the sector. These factors combine to increase the appeal of cheap passive balanced funds going forward. Investors will do well to do their homework and not simply go with the passive manager who shouts the loudest.
Craig Gradidge is a Certified Financial Planner and Investment and Retirement Planning Specialist.