The selloff this year in JSE all share index heavyweights Naspers and Prosus proves the case for active asset management over the more in-vogue passive investing strategies.
That is the view of financial advisers who say retail investors should not ditch their actively managed portfolios in favour of lower-cost index-tracking alternatives purely on the basis of fees. That is despite stock-pickers having consistently underperformed since the outbreak of the global financial crisis more than a decade ago.
As a flood of monetary stimulus across the world lifted asset prices across the board, it became harder to choose winners, reinforcing the case for passive investment strategies that simply purchase securities in proportion to their weighting on a particular index. Passive investing has built a track record of delivering superior returns while also being cheaper.
Even when volatility returned to markets in the wake of the Covid-19 outbreak, SA active managers were thwarted by the dominance of Naspers and Prosus, which were beneficiaries of a surge in demand for technology stocks. At their record highs in January 2021, they accounted for almost a third of the all share index’s value.
They have been having a more challenging time recently, slumping 31% and 38% respectively in 2022. That has reduced their combined weighting on the JSE to just under 12%, meaning their ability to influence the overall value of the index will probably be considerably smaller in 2022 than a year ago — unless the two stocks mount a considerable recovery.
"A big reason the index performed well in 2021 was because Naspers and Prosus, which have a large weighting on the index, performed very well," says Ronel Ferreira, a director at Progressive Wealth, an independent financial planning and wealth management consultancy. "However, now that Naspers and Prosus are underperforming, the index is unlikely to do as well as it did in 2021.
"By simply buying the index you are unable to avoid that underperformance, which is where a well-constructed actively managed fund can come into its own and actually outperform the index."
The debate has raged since legendary investor Warren Buffett in 2008 challenged the hedge fund industry to justify its costs, winning a bet that, including fees, costs and expenses, an S&P 500 index would outperform over a decade.
Since then, investors have increasingly opted for the cheaper and better-performing trackers. So far, retail investors have had very little reason to doubt the strategy.
Over a one-year period, no less than 74% of local active equity funds were beaten by the S&P SA 50, an index comprised of the 50 largest companies by float-adjusted market cap.
Compared with the broader S&P SA domestic shareholder weighted capped index, 47% of SA’s actively managed equity funds underperformed in 2021, according to the data.
Over the longer term, the underperformance of active managers was more pronounced, with a report earlier in March by S&P Dow Jones Indices showing that 89% of equity funds failed to beat the S&P SA 50.
However, proponents of active asset management say that by carefully selecting stocks they are able to limit potential damage to investors’ portfolios by avoiding shares that may be facing headwinds, either due to market conditions or some inherent quality of the company.
Active asset managers also limit their exposure to any one stock to avoid so-called concentration risk, where too much money is exposed to a single asset. That limiting of exposure can reduce the effect on an investment portfolio in a downturn, even though it also reduces upside potential in a bull market.
"Active funds typically limit the proportion of their capital they expose to single stocks — like say Naspers or Prosus — which means you can give up some upside when a large megacap stock runs hard," says Ferreira. "However, that can also help you limit the down-side impact on your portfolio when those megacap stocks underperform, as we are seeing with Naspers and Prosus at the moment."
Harold de Kock, portfolio manager at Independent Securities, says the underlying constituents of any particular index are also critical in determining its investment merits. For example, he says 45.79% of the Satrix financial exchange traded fund is comprised of just three banks — FirstRand, Standard Bank and Capitec — so investing in that index would expose investors
to concentration risk.
"I would suggest that it would be reckless for any asset manager to invest half of a client’s money into just three or four companies," says De Kock.
"A good asset manager needs to balance risk with return, and as such will not be able to complete against passive funds during certain periods of an economic cycle, because of the strong performance of a small number of very large companies. In a normalised environment, a good active manager should be able to outperform a passive fund, both in terms of absolute return and risk adjusted return."
Anet Ahern, the CEO of PSG Asset Management, says that when a few stocks dominate an index it is often due to the market pricing in significant future growth for those shares. That results in them trading at notable premiums.
"When we have these conditions fuelled by low inflation, low interest rates and a high demand for anything that resembles growth, tracker funds will do better," she says.
Fluctuation
Ahern argues that this dynamic can change with fluctuations in the long-term economic growth outlook, resulting in high-value growth stocks correcting over time. The dilemma for investors is that it can be very difficult to determine when these shifts might occur, meaning that a mix of both passive and active investment solutions is the best strategy.
"I believe that a good long-term structure for a fund solution can include both trackers alongside active managers," she says. "That structure should lead to the best chance of achieving good client outcomes during and through many cycles with the minimum of large-scale changes along the way." With Andries Mahlangu
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