Keep an Open Mind in the Active vs Passive Investing Debate

Analysis shows there is potential for good performance from South African domestic equities managers, but it is advisable to choose carefully. More from Mark Tobin of FInancial Mail.

 Summary:

• Global equity fund managers in SA struggled – Every single one underperformed the S&P World Index over the last 10 years, meaning a global ETF or index fund may be a smarter bet.
  
  
• SA domestic equity fund managers had mixed results – 32% beat their benchmark, meaning there’s potential, but you need to pick carefully based on strategy, holdings, and fees.
  
  
• Active managers in short-term fixed income excelled – Over 71% outperformed their benchmark, making this an area where active investing could shine.
  

I would hazard a guess that many FM readers believe active investing can deliver alpha, or outperformance, and that a purely passive approach, such as index funds or ETFs, cannot.

The active investing can be either through picking stocks yourself or by investing with active fund managers who you believe can outperform a comparative index — after fees, of course.

S&P Dow Jones indices regularly publish analyses of how active fund managers perform vs the indexes in their S&P indices vs active (Spiva) scorecards for various global equity markets, including South Africa. Thus, if we outsource active management to a fund manager, perusing this form guide is a worthwhile exercise to ensure we know the past results for our runners and riders before deciding on our picks.



A few interesting data points emerge when looking at the latest Spiva scorecard for South Africa.

The first is that over the most recent 10-year period, 100% of South Africa-based fund managers investing in global equities failed to outperform the index. Not even one fund manager in the study sample outperformed the S&P world index over this period. While the authors don’t disclose how many international equity funds were in this group, they state that the scorecard collated the results from 519 active funds in total from the South African market, so we can reasonably assume a decent sample size was analysed to arrive at this result for this particular subset of funds.

Fund managers focusing on domestic South African equities did better, with just over 32% of them outperforming the S&P South Africa domestic shareholder weighted capped index over 10 years. That does, however, mean that the majority of fund managers who focused on domestic South African equities failed to outperform the benchmark.

The most surprising data point came in the fixed income space. Of the fund managers focused on the short end of the yield curve, just over 71% outperformed the STeFI composite index over 10 years. This performance also held across shorter time periods in the Spiva scorecard for this cohort of managers, with an incredible 91.8% of active fund managers besting the STeFI composite on a one-year basis.

So, what does the above form guide tell us? Suppose you want offshore equity exposure for the long run. Given the paucity of results in the latest Spiva scorecard, an international ETF or index fund might be your best bet.

The second interesting data point emerging from the Spiva scorecard for South Africa is that active management in the short-term fixed income space looks like a fertile hunting ground for selecting active managers to deliver some alpha. Remember that we are talking about bonds, so the return profile is much lower than in a pure equity portfolio. However, squeezing out an extra piece of return on the fixed income side of your portfolio will still compound very nicely over the long term vs picking a purely passive investment vehicle to get your fixed income exposure in a portfolio.

And what of this third group, the South African domestic equities managers? While the form guide suggests there is potential, we need to proceed with caution. The first starting point would be looking at managers who have outperformed on a 10-year basis. On that basis, these fund managers will have been through a market cycle or two, and their relevant stock picks will have been both in and out of favour with the market. Likewise, their broader strategies, be they growth or value orientated, will have been in vogue at various times.

Ten years is also a decent length of time to tease out skill and nous from pure luck.

Next, we must evaluate the fund manager’s strategy, ensuring it aligns with our risk tolerances and needs. Are we looking for a manager who follows a growth-orientated style or one who has more of a value-based style? Review their top holdings on their fact sheet to see if their stock picks align with the stated strategy.

Finally, we need to look at fees, as these will be higher than the passive index option and the benchmark. I prefer a pure equity benchmark instead of a blended sector average return of all their competitors, which you often see on fund fact sheets.

Thus I want to gauge a South African domestic fund manager’s performance against the JSE top 40 or all share index. You may need to work this out yourself if the fund manager uses an alternative sector average benchmark on their fact sheet. However, if the fund manager beats either of those pure equity indices, they will be besting most of their sector peers.

The Spiva scorecard is released regularly. Thus these results can change over time and, indeed, may flip entirely. So it pays to monitor how the various fund manager groups are tracking.

It is important not to be dogmatic when investing, as every strategy, active or passive, and asset class has time in the sun - or, if you pardon the pun, every dog has its day.

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