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As more capital flows into passive investment strategies locally and abroad, inevitably the debate sharpens as to whether passive or active portfolio management is better. As a serious investor, there is merit in applying your mind to the detail of the arguments as many of the sweeping statements around performance compromise, costs, buying-high-selling-low etc are not well founded and certainly need to be unpacked in the face of smart beta products and the progression of index tracking products. SATRIX, South Africa’s pioneer in the index tracking space, has always backed both options as having a place in a well structured portfolio. Helena Conradie chats to Candice Paine about why this is and how you could consider combing both active and passive funds in your portfolio.
This special podcast is brought to you by SATRIX. I’m talking to the CEO of SATRIX, Helena Conradie and we’re going to talk about how to use passive investments in your portfolio. Helena, there’ve been a lot of criticisms against passive investing, especially since the increase in the number of products available and the Assets under Management – the money that’s flowing into the passive space. I wonder if you can comment on that.
Well, I think the first comment I would like to make is that we (everywhere, not only us in South Africa) focus too much attention between the whole issue of passive and active. See this not as flowing into Passive Funds as such. It’s flowing into another option in your total portfolio and there are different times that you’ll increase the use of Passive Funds and they will be part of your total portfolio. It’s always prudent to have a portion in your total portfolio in your Passive Fund. The second comment would be that there’s a myth that passive is a very passive decision. It is not. It is a very active decision so if there are funds flowing into Passive Funds, it’s not because there’s [inaudible 01:19]. It is a very active decision, whether it was to end up in resources, overexposure, into a dividend plus, or actually choose a momentum style. It’s the same one, which you would make as you choose a fundamental Portfolio Manager.
One of the points on the table is that the average Active Manager (that would be somebody who’s doing the stock picking as opposed to Index Tracking) underperforms the index over many of the periods. Why is this?
I think that’s actually one of the points that one should not argue about anymore. There’s enough proof that the average (and the emphasis is really on the average Active Manager here) that they underperform. It could be a combination of factors. I think that if you read Charles Ellis’ book ‘Winning the Loser’s Game’, you’ll see that in general, the market has become much smarter. What you’re trying to do is to beat the guy next door who is as smart and is doing as much research as you are, so the collective market is smarter and on average, it’s very difficult to beat that and all those factors are cost-included. What do we have to admit though, is that there is skill in the market and you don’t find Active Managers (not the average one) that can beat the market and that has skill that can last over the long term. There might be other challenges after that to choose them, but the fact that they are there, is a truth.
It’s a big misconception that because markets are not efficient, you need an Active Manager to capitalise on those opportunities. How have the passive products responded to that?
Well, we agree that markets are not efficient and for that reason, you can (like an Active Manager, as well) extract certain styles or certain premiums in the market. If you think of a Value Manager, what do they look for? They look for under-priced securities and undervalued securities and in their minds, they follow a certain process and obviously, add a little bit of flair. You can do it the same way with the index – in a very systematic way also choose undervalued securities. Look for a low PE or any other factor that can identify undervalued securities. All we do in an index is that we capture that in a very systematic way but we can also capture the inefficiencies in the market.
When you say ‘a systematic way’, you have a methodology or a filtering system on various stocks that form part of an index that is not necessarily the market cap weighted index, and you just systematically track that. Is that what you mean?
Yes, you get two different kinds of indices: one, which is listed and is on the JSE, FTSE, or MSCI type of index. Those index providers have rules and committees deciding every quarter what is going in and out of the index. That’s very much rules-based and rules that are available in the market, so it’s very transparent. You can also do that at SATRIX. We have customised indices so for example, we decide on a momentum strategy. You identify certain factors that are important to capture that strategy in the market and then you apply your rules as well. It means that you rebalance every quarter. You don’t look at the shares on that day, decide that Naspers is overvalued and then sell out of the share. You have a very rules-based methodology to follow your trading processes as well.
What you’re saying is that performance within the market is driven by various factors and through a passive investment, you can capture some of that performance systematically and actually, the bit that you need to pay for is the skill of the Active Manager.
For example, you invest in Unit Trust A; all those returns have some source. There are sources of returns in the market. You have a return of ten percent over the year because of certain factors driving that return. It could be the market in general. It could be an exposure to value stocks, an exposure to small cap stocks, or exposure to momentum stocks. Everything that you can put into a rule and that you can actually capture, you can do through an index as well. The last bit that we call the domain of the Active Manager is where you make a fundamental call on a share that is not capture in any number or any ratio and that’s really, where an index can’t capture that.
Okay, so if we put the active versus passive debate aside and make it a moot point, you’re wanting to build a portfolio now, using Active and Passive Funds. What are the two real issues that it boils down to for somebody who’s constructing that portfolio and wanting to choose the Active Managers? They now understand the passive. They know what drivers/factors they’ve captured. What is it about the Active Managers that they now need to worry about?
I think we can go back to the initial comment that there are skills in the market and that you can find the Active Managers outperforming the market. We have top managers in the South African market as well. For an investor the challenge is really, to pick them before they perform. You know they can perform, but how do you pick them before they win the Raging Bull award? 2. We know that they are nimble. An Active Manager is definitely more nimble than an index because they are not constrained by rules. What you need to check (as an investor) is the fact that they’re nimble… Are they more successful? You need to do your homework. Firstly, what do you want to be exposed to? Is there perhaps a specific demand in your case? Do you want more dividend yield? Then you will pick a Value Manager or you will pick a very specific Dividend Yield Index Fund. The second one is really, to check your cost and whether this Active Manager has proven over time, as well as some other factors. For example, do you think they will outperform consistently over the long term?
You’re saying that the portfolio construction becomes quite a job now, trying to identify the Active Manager that’s going to outperform the passive strategies over time and obviously, whether they’re able to do that at lower cost. Let’s talk a little bit around the cost. There’s a lot of debate in the market that passive investments are not as cheap as they claim they are. What’s your view on that?
Where the confusion comes in is very much the numbers that are always quoted from an international perspective. People ask why can’t we also offer funds at ten basis points and that’s ten basis points versus one percent that the average Active Manager charges. There are different types of funds, whether you go in as a direct retail investor or whether you go in as a big Pension Fund. Those quotes that they always do (that is very low) is on very big Pension Funds. The fact is Active Funds are more expensive than Passive Funds. By how much – that’s where you need to check it. For you as a retail investor, there’s definitely not even a single doubt that this is a much cheaper way of accessing the market.
Helena, thanks so much. You’ve given us a lot to think about in the active and passive debate, not active versus passive debate. That was Helena Conradie, CEO of SATRIX.
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