Passive funds are big business overseas, with most pension funds using them as core investments and using specialist funds as performance kickers.
Passive funds are exactly that. They simply track an index; there is no fund manager actively buying and selling shares and trying to out-perform the market. Hence, passive funds tend to be quite a bit cheaper.
Despite the fact that research has shown that these types of investments offer extremely good value for money, South Africans tend to ignore them.
Unit trust index tracker funds attract the least inflows in the industry, and some asset managers have even closed their tracker funds.
Industry commentators believe the main reason is that despite grumbling about fees, South Africans are driven by the advice of financial advisers. Advisers believe they must be seen to be adding value and they fear sticking a client into a tracker fund may be seen as an easy way out. Besides, tracker funds tend not to pay commissions.
However, index tracking, or passive investing is an important building block in any portfolio and costs are generally much lower than for actively managed funds.
A study published by Roland Rousseau of Deutsche Bank last year showed that over the past 20 years a fund manager would have to outperform the index by 58% in order just to cover the drag of active costs. More-over, other research shows that in the long run, two-thirds of fund managers underperform the index after costs.
This is because the behaviour of market returns has a great deal to do with the performance of the top 40 shares on the JSE. The top 40 make up about 85% of the FTSE/JSE All Share Index. Because they are the most heavily traded shares, with the greatest liquidity, the more money the manager has to manage, the greater his exposure will be to the top 40. It is a great deal cheaper to buy an index tracker or an exchange-traded fund such as Satrix40, which will perform in line with a large fund manager anyway.
There are two ways for an investor to invest in passive funds: through a unit trust index tracker or an exchange-traded fund (ETF).
The latter are very popular overseas, with 390 ETFs with 490 listings on 31 exchanges worldwide. Internationally, 40% to 50% of all institutional assets are in index or passive portfolios. Basically, an ETF is a basket of shares that passively tracks an underlying index and is itself listed on a stock exchange.
In South Africa we have nine ETFs: five Satrix securities, which track various JSE indices, two Itrix securities, which track global indices, and two Absa ETFs that track the gold index and rand hedges.
They are similar to the index-tracking funds offered by the unit trust companies. The difference is that they can be purchased through a stockbroker as an ordinary share. Depending on the value of the trade, the costs can be substantially lower than for actively managed funds.
The annual fees are also lower as they do not require the skills of an active fund manager. They charge an annual fee of 1%, while most actively managed funds charge double that.
An investor can use an ETF to create his or her core equity portfolio. Actively managed funds can be used to give the portfolio a specific sector bias. Investors who prefer to invest directly in shares can create a share portfolio around their core holding, buying companies they believe will outperform the index while having share diversification through the ETF.