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Strat Doc 1Q18 – Active vs Passive Investing

29 January 2018

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by Lee Cairns

Having returned from the annual coastal crusade many South Africans embark on for the month of December, it was no surprise to be involved in many Active vs Passive braai conversations. December, marking the end of a calendar year, has become synonymous with braai time reflections on whose investments did and did not enjoy a celebratory year.

2017 will certainly have been no exception, what with the JSE Top-40 ETFs outperforming 90% of active managers. So, it would appear that the conclusion must be obvious, everyone should be switching to the cheaper, betterperforming, passive market trackers.

The JSE has become one of the world’s most skewed markets, with Naspers now accounting for 25% of the JSE Top-40 Index. The Naspers share price rose 75% in 2017. So, by making the decision in January 2018, that you should be shifting your SA equity investments into a JSE Top-40 ETF, you are in fact directing 25% of your equity exposure into one share – one share which has risen by 75% in the previous year and which relies entirely on the stability of Chinese business legislation.

There is no doubt that passive investing globally is here to stay. The argument for passive offshore investing is far stronger than the argument for the same within SA. The reasons for this are twofold: a) the cost of investing in ETFs offshore is less than one-third of the cost of ETFs in SA, and less than 1/10th of the cost of offshore active managers; and b) the depth of the market abroad, most notably in Developed Markets (DMs), is so broad, with little to no arbitrage of information available, that the skill of active management offshore is under continuous and significant pressure. That is not to say that active offshore management cannot deliver significant outperformance. Excellent managers, those with the discipline to stick to their tried and tested styles, continue to deliver. 2017 was a strong example of this.

In order to outperform, active management not only relies on robust sector allocation through cycles, but also on the ability to unearth gems in the smaller- to mid-cap space. These companies tend to be less covered by analysts, and therein often lies the opportunity to discover the gem the man on the street does not have the resources to find. It is also these companies which do not have a place in the various JSE Top-40 Index trackers, and have, when analysing the top active fund managers in SA over the last 10 years, tended to be the companies which have delivered much of the significant market outperformance.

With SA’s political woes, small- and mid-cap companies, which rely on reasonable GDP growth and government stability, have been the ones to avoid. But with political change afoot, is it now the time to take the active decision to avoid these forever?

I am not a betting man, but if I was to wager a small bet, I am fairly confident that we will look back at January 2018 and realise, with the benefit of hindsight, that January 2018 was not the time to make a wholesale investment strategy switch into passive investments.

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