Jannie Leach is the Head of Core Investments at Nedgroup Investments. He spoke to Alec Hogg about passive investing and why it’s taken South African investors so long to cotton on.Â
Why do you think it’s taken so long for South Africans to click to the appeal of passive investments?
There are a number of factors. I think there’s been a lot of a regulatory changes over the last three years, and then there’ve also been changes, in terms of the products that have been made available to clients. For example, one of the major trends in the South African market, over the last few years, has been the move towards what is known as Member Level Regulation 28 Compliance, which basically requires investors, in a Retirement Annuity or in a Pension Fund, to be compliant with the Pension Fund asset limits, set out to them, by the Pension Fund Law.
Previously, you could actually put 100 percent equities into your Retirement Annuity, and as long as the whole fund (in other words, all of the clients that have invested in that particular annuity) was compliant, nobody had to change their asset allocation. However, when the laws changed to a Member Level (in other words you, as an individual, need to comply with those asset-class limits) it basically moved the market over to the multi-asset space – all your old, additional funds that were used for Retirement Annuities and for living annuities.
What was the thinking behind forcing individuals to have a more balanced portfolio?Â
I think, historically, the idea of having those limits has been to manage risk, within a portfolio, so if clients only invest in specific asset classes, those specific asset classes have very specific risks. A number of them, for example, equities can be quite volatile, from time-to-time, so in order to manage the risk, to give the client, especially over a long-term, the best return versus risk benefits, a sort of an optimal mix of asset classes was prescribed by the regulators.
It normally limits the amount of offshore that’s held within a portfolio. It limits the amount of risk assets, for example your equity and property, so it is more to give a client a more balanced solution, that can sort of withstand different kinds of market conditions.
With a long-term investment horizon, as you would with Retirement Funding, why not just stick with shares, why also have to put money into fixed interests?
I think it is more just to manage the short-term risk, especially when you are near retirement. That kind of drawdown risk becomes a bigger and bigger concern. Then having some downside protection adds some benefits, and I think that is why a lot of your Pension Funds make use of Life Stage strategy, to reduce that capital loss during those years just prior to retirement.
Passive investments have taken a while to really grab the attention of South African investors. ETF’s are only now becoming a better known here…..Â
I think it is partly because it has been quite a new aspect or new investment within the market, but I think the major reason is more structural changes that happened during the late 90’s and early 2000’s. I think the two major changes that happened was, one, the move from the Fund Benefit Schemes, over to the Fund Contribution Schemes. That gave rise to all the new boutique style active asset management houses that we’ve become so familiar with over the last few years.
At the same time, in the retail space, you saw the launching of Lincoln Investment Service platforms, in other words, platforms where you could access different kinds of Unit Trusts, and that saw the rise of, what is now known as the Independent Financial Advisor. The Independent Financial Advisor is no longer tied to a life company or a bank, and you saw a shift in the move from using life policies in the retail space to using investment products.
I would say that that trend meant that when the financial advisors first were introduced to Unit Trusts, there was quite a wide range of active managers available to them. If you think of, from a business perspective, managing an asset management company, if you try to start a boutique-style index management house where your margins are incredibly low, it is incredibly difficult.
It’s actually a lot more complex than a lot of people make it out to be, but I would say that those structural forces, to some extent, meant that the index fund industry took much longer than most people would have expected. As I say, it is only over the last two or three years, that our asset management industry has matured sufficiently that it could provide truly low cost solutions to the market. I also think that our investors have become more familiar with the index fund, so they demand those kinds of low cost funds as well.
It’s a lovely history, the way that you’ve outlined it there but if one looks into the future, given that we’ve caught up only recently; are you expecting passive funds to take an ever-increasing slice?Â
Yes, I’ve definitely seen it in our funds, as advisors and investors, in general, become more comfortable with passive investments, and as passive investments build up track records, I would think that a similar trend to what we’ve seen internationally, will slowly but surely, rollout in South Africa. More and more investors will make use of these passive products, specifically in your passive balance funds. Over the last 15 years your pure single asset class, equity unit trust, for example, hasn’t really attracted any flows. The vast majority of assets have gone into the multi-asset space.
Yes, and that comes back to what you were saying earlier, about the Regulation 28.
The Regulation 28, yes.
Is there a level where you would expect the percentage invested in passive funds to level out?
Yes, look, I think what investors always need to understand is that effectively passive management can only exist if there are active participants in the market, and it is those active participants that basically derive or give you the prices, or the index that you end up investing in. There must be some natural, I would say, plateau for asset management in a market. Where that is exactly, I don’t know and nobody can really say. I think, in time, we’ll probably figure out where it is working and where it doesn’t.
Yes, but there’s still some way to go until we get there.Â
There’s still a long way and in South Africa, I think there is only four percent of our total assets that are invested in passive at the moment.
What’s it like elsewhere in the world?
Currently the U.S., funnily, has 24 percent of all equity funds, about a third of all equity assets in the U.S., is currently in passive or index styled products. I think it is taking between 50 and 75 percent, of the net new flows into the market, currently. It is definitely, where most of the new investments are going.
And as far as Nedgroup Investments is concerned; you guys are very famous for picking out the best boutiques. Are you finding expert index managers or doing it in-house?
I think in the passive space it is a little bit different, so we do make use of ‘best of breed’ managers, for example, our Core Range is managed by Taquanta Asset Management. They manage all our cash funds and our passive funds, but I think especially in the passive balance space, it requires a slightly different skill set. For example, it requires the implementation skill set that you want from an index manager, but it also requires an asset management product development skill set. I think with our Core Range, we’ve been able to use our ability to do asset allocation and product development and combine that with the Taquanta skill set, which is ‘how do you implement index funds efficiently’.
I would say the Core Funds are more a synergy or a collaboration between Nedgroup Investments and our ‘best of breed’ partner, on the local side, which is Taquanta. Offshore, thus far, we are making use of Global ETF’s.
Yes, and you also recently, yourself, visited Vanguard. That must have been an experience.
Yes, that’s an amazing place to visit. It is almost like a university campus. I think they call it a campus. I was fortunate enough to spend a day there, and I was taken to the floor where all the portfolio managers sit. I think it was about 16 portfolio managers that manage $1.3trn worth of assets, worldwide assets.
Extraordinary. Did you learn anything there that you’ve been able to implement?
It was more interesting to actually, look at the way that the industry has evolved. Now, there are very similar trends in the U.S. industry to the South African industry, and specifically around accessing funds via linked investment service platforms or platform, and then specifically, I would say, the emphasis on what they call guided investment platforms or limited architecture platforms. In other words, because there’s so many funds available to clients, where the number of funds are limited to key players, it becomes quite a challenge for most participants to actually, get on those platforms.
Fascinating insights from Jannie Leach. He is the Head of Core Investments at Nedgroup Investments.Â