Blurring boundaries - new trends in SA asset management industry

10 October 2016

The growth of passive or index investing is one of the more far-reaching global investment trends to emerge over the last several decades. 

Since the launch of the first exchange traded fund (ETF) in the United States in 1993, ETFs and other types of passive investment vehicles have opened a whole new vista of opportunities for investors around the world and in the South African market.

In 2016, index investments dominate growth in the global asset management market, with reported assets under management in passive mutual funds having grown 203% to $6 trillion since 2007. Exchange traded funds are currently a $3 trillion market with 6,780 products traded across 60 exchanges globally. 

Initially, ETFs and index products were perceived as merely an inexpensive way to obtain exposure to overall market performance as measured by large benchmark equity indices such as S&P 500, FTSE 100 or, in SA, JSE Top 40.  Today, investors can access multiple asset classes through passive products – from equities and bonds to property, commodities and preference shares amongst others.

More importantly, the boundary between traditional passive and active asset management is becoming increasingly blurred with the emergence of so-called smart beta index products. What is smart beta? Academic research in financial markets over the last half century has demonstrated that market returns can be explained by a small number of drivers, or factors. Early research by Fama and French identified three such factors contributing more than 90% of diversified equity portfolio returns, these being market, size – e.g. small cap and value. Later, new factors (momentum, low volatility or low beta, quality, etc.) were added and the same approach was applied across asset classes. The consequences of all this are profound – the  significant proportion of excess market returns, previously the domain of active asset managers can now be captured by systematic strategies that can be implemented in an index form – known as smart beta indices - and invested in a cost-efficient way by smart beta index trackers.

Of course, it does not end there. Which smart beta strategies to invest in presently? Is now the right time to invest in, say, a value index or a momentum index? When to switch?

Academic research in financial markets over the last half century has demonstrated that market returns can be explained by a small number of drivers, or factors.

The new generation of approaches – the so-called multi-factor strategies attempt to answer these questions and provide investors with solutions that are robust and flexible enough to generate superior risk adjusted returns in changing markets.

Such strategies can also help in resolving the active-passive dilemma by creating solutions that combine the some of the best characteristics of active asset management – deep understanding of markets, macro-driven forward looking views, thoughtful stock selection,– with a disciplined and structured approach of passive and smart beta indices.

In the end, however, investors are not interested in such complexities – they care, instead, about achieving their investment goals – saving for retirement, children’s education – or next year’s holiday – in the simplest, least risky and most cost effective way. Almost always, they are happy to leave the complex choices to professionals. 

Outcomes based solutions are centred on the investors and their objectives – quantified by their real (after inflation) return expectations and risk appetite over a specified investment time horizon. The best such solutions are well diversified across asset classes and investment approaches (e.g., utilising both active and passive building blocks), robust and sensitive to changes in market conditions (i.e., not static), risk focused (getting to the desired outcome with the least amount of risk taken) and cost effective.

This focus on investor needs and related investment outcomes simultaneously renders the arguments around active vs passive, unit trust vs ETF less relevant. The choice of the most appropriate combination of building blocks and the most appropriate delivery format stops being based on opinions – it instead becomes a rational process of optimisation – satisfying investors’ stated objectives at the lowest cost and in the simplest and the most appropriate way within the operational and regulatory environment.

Note on the authors:

Dr Vladimir Nedeljkovic is the Head of Fund Solutions at Ashburton Investments. The Fund Solutions business comprises of Multi-Manager, Quantitative and Index Solutions. Samantha Schoeman runs the Index Solutions business within Fund Solutions

Index Solutions comprises of 6 index tracking funds where smart beta (momentum, low beta and value), global and traditional market capitalization (property and government bonds) indices are tracked, as well as 3 ETF’s (Top40, MidCap and Inflation). Multi factor strategies form part of the extended product offering within Index Solutions. Multi Manager runs 5 outcomes based solutions, being the FNB Horizon Series, as well as 5 multi manager funds across asset classes (equities, bonds and property).