Edition: August/October 2018
The changing tides in SA equity investments
In fine-tuning an investment strategy, John Taylor of Liberty Corporate urges that not only costs but also their relative benefits be carefully examined across extended timeframes.
Over the past few years, amidst a slowdown in local equity-market returns, there have been distinct trends from actively-managed assets towards index-tracked assets. Coupled to this is the fall and rise in the popularity of ‘value investing’.
Actively-managed investments are usually managed by traditional asset managers. These ‘value’ managers employ their own proprietary systems and philosophies to determine which shares to hold for their customers.
While this has been the norm, there has been increasing discontent amongst customers that a majority of traditional asset managers do no better than their benchmark (which usually is just a collection of all the shares in the market). Only a handful are said to add value beyond the benchmark.
To focus particularly on the movement of actively-managed assets towards index-tracked assets, it is best to consider international experience.
By the end of 2016, it was estimated that at least one-third (or 33%) of assets in US mutual fund (equivalent to South African unit trusts) are invested in passive funds. Further, ratings agency Moody’s suggests that the volume of passively-managed assets may overtake active funds by 2024.
South Africa has similarly seen the rise of a number of passive-only asset managers. At the same time, the main life insurers all offer passive strategies to complement their traditional active offerings.
Historically, many active managers have added value. A cursory visit to any of the current large investment houses’ websites will bear testimony.
Active management works when managers can research shares which are either more or less valuable than their current market price suggests. By buying cheap shares or selling expensive shares, asset managers aim to outperform the market.
On the flipside, research also suggests that as market information increasingly becomes freely available, the efficiency or “correctness” of price information in the market improves. So it is fair to suggest that, as information becomes more widely available to the average customer, the space for active management is likely to dwindle.
As expected, many retirement-fund boards and corporate investors have put pressure on their asset managers to prove their value. This has resulted in a general shift to lower fees. The downwards march continues.
Asset consultants have been eager to placate retirement funds’ boards by indexing a majority, or a “core”, of assets by using cheaper index trackers -- while still retaining more active managers as an additional, or “satellite”, set of managers.
All this means that large investors have seen asset-management costs reduce from over 1% per year towards 0,6% to 0,8% in the last few years. More pressure will be felt as the pressure of lower market returns highlights the impact of fees on reducing overall returns.
The relative impact of a 1% fee compared to equity returns on the JSE all-share index in the last five years has increased from removing 4% of total returns in 2012 to removing 38% of total returns in 2016. If that fee in 2016 was only 0,6%, the impact last year would have been only 23%. It’s still a lot but much less than 38%.
If Mister Market is doing all the heavy lifting, as in 2012 and 2013, fees play a smaller role. But as markets have flat-lined between mid-2014 and today, any underperformance of the market (net of fees) is felt more acutely.
And then comes the fall and rise of value investments. Value investment, counter to passive investment, suggests there definitely are undervalued and overvalued shares in the market. While investing in cheap shares has been demonstrated to add to performance over a long period of time, this can frustrate investors from year to year as this value can take time to unlock.
By their own admission, value investment houses in South Africa – such as Piet Viljoen’s RE:CM and Adrian Saville’s Cannon Asset Management amongst others – had a torrid patch between 2013 to 2015. This was when the resources sector moved deeply into value territory and continued to weaken further.
But by 2016 the starts of a recovery had begun and value investing added massively. While the JSE all-share index returned a paltry 2,6% over 2016, the value index gave something closer to 17,2%. But beware that, as quickly as value investing adds to returns, it can reverse out for a period of time.
In summary, be aware that including a passive element in your investment plans is important to consider. Focus on the costs and benefits that you’re getting for what you are paying. By asking these questions, one can fine-tune and hone your investment strategy appropriately.