Roger Federer won about 80% of the 1,545 singles matches he played in his professional career, despite winning only 54% of the points he played.
While he served exceptionally well (being in the top decile for aces), he was by no means the best or the fastest server on the circuit. Nor were his forehand or backhand winner percentages near the top. Instead, his all-round consistency and low error rate wore his opponents out in most matches.
If we compare the after-costs performance of vanilla index strategies (often termed passive), such as the FTSE/JSE Capped Swix, to the performance of the median active manager in the Association for Savings & Investment SA (Asisa) general equity category since 2004, the results are strikingly similar to Federer’s record.
The index beat its active counterparts 57.5% of the time monthly, while beating the active manager median about 79.5% of the time over a rolling 36-month time period. For other popular indices, such as the all-share index and top 40 index, this number is even higher.
This means despite beating active managers only marginally monthly — similar to Federer — the low “error rate” in terms of trading and management costs and style consistency mean index funds tend to wear out most active competitors on a time frame beyond a single monthly data point.
If you were then to pick a team of players at any time over the past 20 years, you’d probably want to include some of the big-hitting servers or players with the best recent performances or someone with a style matching the available surface. In all cases though, you’d most likely also pick Federer to be on your team — simply because you know you’d be stacking the odds in your favour by doing so. The same applies to index funds.
But index funds are not all the same either. As the Capped Swix is a market-capitalisation-weighted index, it uses company size as the metric to weight stocks. Other index strategies also refine these simple rules. Factor indices aim to identify attractive attributes of companies, such as measures of balance sheet quality, earnings growth, price momentum and measures of value, to pick and weigh stocks.
Follow rules
Thematic indices aim to capture themes, such as healthcare, climate disruption and technology. The common thread for index funds, vanilla and nonvanilla, is that they follow a set of rules. Investors thus know what they are investing in. The costs also tend to be much lower than that of active peers, with consistency and transparency in design a key feature.
If the history of investing has taught us anything it is that successful investment strategies need not be like suspense novels in which the reader is left guessing; knowing exactly what fund building blocks do means advisers are better able to create portfolios that work well in different scenarios.
Transparency in terms of cost and design is a big benefit — one that is well embraced in the US equity market, in which index strategies last year outstripped active funds as the largest segment by assets under management.
The question whether to hold passive (vanilla index funds) or active (which should include as a subset non-vanilla indices) is misplaced. The answer should in truth be both — with the optimal proportion being debatable. There are two reasons for this argument.
Both have an important role to play. Active managers play an integral part in price discovery and, by virtue of not being tied to a specific lens through which the world is viewed, offer the possibility of finding unique opportunities.
Non-vanilla index strategies can also add tremendous value through systematically harvesting return premiums that have been proven to deliver results over time — especially if held through cycles. Vanilla (or passive) indices pick themselves, the same way that Federer makes any tennis dream team over the past 20 years: buying broad market exposure at the lowest price point simply makes sense.
Blurred lines
Another reason is that the lines between traditional passive and active strategies in SA have been blurred in recent years. Over the past 10 years, the aggregate level of active share (or how active an active manager truly is relative to the benchmark) has halved. Active managers are thus in fact far more passive now than before — to the point where nonvanilla rules-based index funds are, on aggregate, as active as traditional active managers. There is therefore nothing inherently passive about index strategies, nor anything particularly active about active funds.
The simple active-passive dichotomy is therefore no longer a relevant description of the available fund strategies investors should consider. Designing portfolios with building blocks that have well-defined roles and best meet your objectives, while knowing what you pay, remains the real challenge for investors (or their advisers).
While the investment portfolio options and styles available are myriad, having Federer in your stable is always a good start.
• Katzke is head of portfolio solutions at Satrix, a division of Sanlam Investment Management.
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