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Publication

BUSINESS DAY

Page

5

Date

Tues 04 Aug 2020

AVE (ZAR)

36651.93

INSIGHTS: NINETY ONE SOUTH AFRICASponsored content

Volatility stirs activevs passive debate®Key to successand significantrewards ispickingthe right activemanager, writesPedro van Gaalen

s investors assessthe damage totheir portfoliosfollowing theCovid-19 market

selloff in March, many arereevaluating their investmentstrategies.This analysis hasthrust the perennial activeversus passive fundmanagement debate to the fore.

The unprecedented marketturmoil saw the JSEAll ShareIndex (Alsi)deliver itsworstone-month decline, shedding34% between February 19andMarch 19.However, a robustrecovery followed with the Alsirecovering by 48% by the end ofJuly. These swings put the activemanagement value propositionto the test.

In principle, volatility createsopportunities for activemanagers to tilt portfolios awayfrom risk during amarket selloffto mitigate drawdowns, andstrategically reinvest in riskassets during a recovery tooutperform the market.

This agility and flexibilityshould enable active managersto outperform passive index-tracker funds, which wouldjustify their higher fees.But thisis not always the case.

"Justas all passive indicesaren't created equal, neither areall active managers.While someconsistently outperform, otherspersistently underperform themarket," explains Sangeeth

Sangeeth Sewnath ... value.

Sewnath, deputy MD at NinetyOne South Africa.

For context, a working papertitled Mutual Fund Performanceand Flows During the Covid-19Crisis by Lubos Pastor and MBlair Vorsatz found that most USactive equity fundsunderperformed passivebenchmarks between February19and April 30.

When measured against theS&P 500, 74% of active fundsunderperformed the index. Theaverage underperformance was-5.6% over the 10-week period.

Amid these variable results,the active management brandhas taken a knock due to thesector's average performance inthe current cycle. However,reductionist thinking, whichdraws insights from narrowpoints in time to form long-termconclusions, muddies the activeversus passive debate.

"Despite the challengesfacing the industry, the activemanager proposition remainsstrong, particularly whenconsidered against longer-termtrends," affirms Sewnath.

"Comparing performancebetween active and passivefund managers is complex.Investors need to understand

how a fund performs over time,which is amore meaningfulway of analysing the data tomake informed decisions abouttheir investment strategy."

For example, Sewnath saysthe Alexander Forbes GlobalLargeManagerWatch(LMW)survey offers insights into fundperformance based on rollingthree- and five-year returns.The survey has a homogenousdataset that goesback to 1995.

Sewnath compared this dataagainst theWillis TowersWatson Composite Index, whichis fairly aggressive with a 65%equity allocation, 27% offshoreexposure and 5% in property.

"We found the median activemanager beat the index by 47basis points per annum basedon rolling five-year returns,gross of fees.While gross of feesis not ideal, the homogenouslong-term dataoutweighs thedownside, provided you canadjust for the fee clients pay."

Ultimately, active andpassive outperformance iscyclical. There are times whenactivemanagersoutper formand times when theyunderperform the market, butanalysing performance over anextended period demonstratesactive manager persistence.

"There have been timeswhen 100% of active balancedmanagers in the LMW surveyoutperformed the market overrolling three- and five-yearperiods, and there are timeswhen this figure is as low as10%-20%. On average, 62%-63% of active managers in thesurvey outperforms thecomposite index."

A similar pattern emergeswhen comparing equity fundsusing Alexander Forbes surveydata. "On average, 52%-62% ofactive equity managers that arenot benchmark cognisant

outperformed three majorindices - the ALSI, Swix andCapped Swix - by between1.3%-1.7%per annum on averagefor three- or five-year rollingperiods, depending on thebenchmark index."

In this context, it is worthconsidering whetherunderperforming activemanagers rely too heavily onindex mimicking.

"Index plus or minus activefund management is becominga more difficult proposition tosell. Unashamed active fundmanagers like Ninety One thathave conviction in their viewsultimately deliver investor value.Those trying to straddle this linewill continue to lose relevance."

Beyond index performance,local investors must alsoconsider the risks associatedwith a lack of diversification inpassive investments.

"Many South African equityindices hold a concentration ofbig-cap stocks like Naspers andProsus. Without adequate riskmanagement, this could resultin up to 30% exposure to asingle stock. Opting for a top 40index also excludes mid- andsmall-cap stocks."

Sewnath believes a strongcaseexists for including activeinvesting in a portfolio.

"The key to successandsignificant rewards is pickingthe right active manager, withpersistence the ultimatebenchmark. However, investorsshould also consider whetheran active manager deliversreturns in line with their specificobjectives." he says.

"This is where a financialadvisor is crucial and addssignificant value."

Ultimately, passives keepactive managers on their toesand working hard to continuedelivering value for money.