South Africa vs global trend
Not all trends are worth following, but the passive investment one may well be worth taking note of. In the investment market in South Africa we have seen slow uptake of passive investments. However it should be noted that we have, in the past few years, seen some notable growth. Currently, passive investments constitute approximately 9% of the market share – relative to the 91% in active investments. This is a significant rise from just 3% in passive investments five years ago. This growth trajectory suggests that passive investing could potentially see its market share double in the next 10 years. Interestingly, this passive investing share remains far below the global trend, where passive investing seems to be approaching parity with active management in some markets. In the United States, there has been a cumulative net flow of more than $2 trillion from actively managed domestic equity funds to passive ones, primarily in Exchange Traded Funds (ETFs).
Challenges with passive and active
Passive has its challenges. For starters, you are never going to outperform the benchmark after fees. In addition, many providers struggle to match the index exactly, leading to index tracking performance leakage – also known as tracking error. And lastly, critics argue that South Africa’s market is too small, with too few participants, for passive investing to be effective. South African providers finding ways to overcoming some of these challenges, would certainly make passive investing that much more compelling.
On the active management side, an analysis of the ASISA South African equity general category reveals that the average active asset manager frequently struggles to outperform the index, especially over longer periods. Statistical data shows that only 47% of actively managed funds outperform the index in any given calendar year. This illustrates the inherent difficulty in achieving consistent outperformance through active management.
Data also indicates that active managers often underperform during bull markets, where broad market gains make it challenging to stand out. This highlights the critical role of manager skill in achieving superior returns. While many active funds fail to consistently outperform the index, select funds and managers succeed over the long term. This reality makes the careful selection and ongoing monitoring of skilled managers essential in investment management.
So what are the benefits of passive then?
Despite its challenges in the South African context, passive investing offers significant benefits, including simplicity, low costs and broad market exposure. Investors can gain diversification and mitigate risk through low cost index funds or ETFs, making passive strategies particularly attractive for those new to investing or lacking the time or expertise for active management.
In addition, the performance of an index is not dependent on market size, the number of constituents or liquidity. The notion that South Africa is fundamentally different from other markets is not supported by data.
Make no mistake, we believe that good active asset managers are able to deliver benchmark beating returns. The skill of identifying and partnering with exceptional managers who consistently deliver superior returns is something which will continue to be worth paying for. It is crucial to note that this does not mean passive investing is inherently better than active investing or vice versa. There are active managers who achieve significant outperformance, even after fees. These managers can identify and exploit market inefficiencies, providing substantial value to investors.
So which strategy is better?
Our belief is that there is place for both, while passive strategies are designed to track indices rather than outperform them, they are crucial in constructing a comprehensive and efficient investment portfolio. This role is often underestimated, especially in emerging markets like South Africa. We advocate for a dual approach that combines the strengths of both active and passive strategies. Incorporating passive investments into a portfolio provides a solid, cost effective foundation, while active management adds value through strategic insights and targeted opportunities. This combination can enhance portfolio performance, offering both market-matching returns and above-average gains.
For long term portfolios, especially those aiming for sustainable growth, integrating both approaches is particularly effective. This blended strategy allows investors to achieve cost effective market exposure while benefiting from the potential outperformance that skilled active managers can provide.
