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Blending passive and active investing

ARTICLE BY

  • Hayley Brown

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In the face of the current economic climate, many investors will seek the most cost-effective opportunity and weigh up the pros and cons before choosing a suitable investment product or service. Similarly, as an investor, you may also be increasingly more fee-conscious when considering an investment.

Initiatives such as the Effective Annual Costs (EAC) standard, introduced in 2017 by the Association for Savings and Investment South Africa (ASISA) members enable investors to compare the fees and costs of investment solutions from various service providers.

EAC provide a standard disclosure of the charges that an investor will most likely incur when investing and holding a specific financial product.  The most recent change of the EAC, which became effective from 1 March 2019, compels all financial service providers and retirement funds to comply with the standard on retirement savings cost disclosures.

Both standards endorse full disclosure of costs levied by administrators, advisers and asset managers. This level of disclosure empowers and educates investors on their investment choices in the pursuit of wealth creation.

Active Investment

This aims to find opportunities to outperform the market. Skilled portfolio managers gather, analyse and interpret data and select companies they believe are likely to beat a predetermined benchmark. Asset managers rely on extensive research, professional judgment and industry experience to actively buy, hold and sell securities in seeking to generate alpha (returns in excess of a market index). The downside of the active approach is that many managers find it difficult to deliver on this objective consistently.

Passive Investment

This involves investing in baskets of securities that replicate a market index or benchmark (also referred to as an ’index tracker’ and Exchange Traded Fund), instead of trying to outperform the market. In other words, an index tracker seeks to match market returns as closely as possible. Passive investments are generally more cost-effective, due to simpler administrative requirements resulting in lower transaction fees and a saving on research costs.

Why choose one when you can combine both passive and active investments

The active versus passive conversation has had very strong arguments on both ends of the spectrum. Despite all the great thinkers contributing to the debate, the answer is not active or passive but it’s both.

A strategic blend of active and passive allows a more holistic approach. Combining them decreases dependency on the market cycle. In addition, using passive investment in active portfolios reduces costs.

The below example blends the PPS Balanced Index Tracker Fund (A2 class) with three of the most popular retail funds of the last year based on ASISA retail flows. The table illustrates the reduction in fee that the client experiences when introducing a passive fund to an existing active portfolio.

PPS - Active vs Passive investing

PPS Balanced Index Tracker Fund

The PPS Balanced Index Tracker Fund is a passive multi-asset high equity option for long-term investors, based on the carefully constructed PPS Balanced Index. There will be times when the PPS Balanced Index will underperform active managers, but we believe a portfolio tracking this index will provide a useful diversification for investors seeking to combine active managers with a core tracking portfolio in the solutions they construct. The portfolio has been constructed as an appropriate Regulation 28-compliant solution for South African investors saving for their retirement.

The PPS Balanced Index Tracker Fund has grown to over R500 million, and the increased scale has allowed us to reduce the management fee to 40 basis points (bps). As a result, the total investment cost is expected to drop from the current 80 bps to around 65 bps.

Fee and cost structures within investments are now clearer and more standardised across investment service providers as aligned to government’s ongoing retirement reform, but we recommend that you consult a financial adviser before making any investment decisions.

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