Index investing, specifically exchange traded funds (ETFs), started gathering pace in SA about 15 years ago, with ETF industry professionals such as Mike Brown, Nerina Visser and Roland Rousseau passionate about tracker funds and why they are so much more effective than expensive active fund managers.
This passive approach to investing is now associated with the latest buzzword in financial markets, being “evidence-based investing” (EBI).
EBI uses appropriately long-time frames, and evidence that is robust, rational, repeatable and has statistical significance. It combines this foundation with low costs, desired performance returns and suitable diversification, and comes up with a passive investment offering.
There is no sales agenda, no marketing spin, just the evidence that passive beats active most of the time.
— Robin Powell
“There is no sales agenda, no marketing spin, just the evidence that passive beats active most of the time”, says journalist Robin Powell, giving the keynote address at a recent CoreShares conference in Johannesburg. He claims that empirical evidence gathered over several decades shows conclusively that only about 1% of active fund managers indeed outperform on a long-term after-costs basis.
Intuitively, the passive approach seems wrong. Surely active investing involving research, stock picking, market timing, well-analysed decisions and refined investment styles must result in a better than average performance? The EBI camp answers with a resounding “no”.
What about in sideways to downwards market conditions – surely the tracker funds simply head south, and the active guys now have the advantage with their ability to switch and counter the trend? Powell explodes this myth and says that again, all the evidence suggests that, even under such circumstances, passive investment beats active management.
Despite significant educational efforts, as well as compelling evidence gathered over 80 years and across all markets including emerging ones, the ETF arena in SA remains a modest one, unlike the US or the UK. The problem of poor take-up apparently lies with the huge marketing budgets of the active fund managers, enabling them to promote their outperformance claims – although these are criticised for being short-term time periods, which perhaps do not reflect the long-term story.
Tracker funds do not have the luxury of huge public relations, as their costs are low in comparison to the active offerings. “You make far more money marketing high-margin products than by telling the truth,” says Powell.
Typically, according to Powell, passive funds in the UK charge about 0.2% in fees. In SA, the figure is nearer 0.35%, and in the US, the world’s largest ETF market, fees average less than 0.1% This compares with about 2%, perhaps sometimes higher, for a standard actively managed fund, with frequent transaction and high people costs. Over time, these cumulative embedded costs eat away at any returns the active manager earns, thereby contributing to a consistent long-term lack of outperformance. And the low-cost structure of EBI products notably comes to the fore in low-return markets in which there is less scope to absorb charges.
Powell quotes what he considers to be an enlightened financial adviser who advocates the evidence-based approach. “The best thing is that we only spend around five minutes of every client meeting talking about investing. The rest of the time we talk about the client and his or her requirements.”
During these one-on-one consultations, there is more scope for analysis of needs such as trusts, taxation issues and succession planning. This contrasts to an actively managed approach in which the adviser spends most time discussing the minutiae of individual portfolio stocks, a task for which many may not be particularly well-equipped.
“First they ignore you, then they laugh at you, then they fight you, then you win” says Powell, referencing the huge effort required in showcasing and eventually convincing advisers and investors as to the benefits of passive investing.
This column will not go down well with active fund managers. If someone out there can make a credible counterargument to passive investing, it would be insightful to listen. Let’s give right of reply to the active camp.
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