Three benefits of using passive investing in your portfolio

Passive investing has seen a dramatic rise over the past decade, particularly in the US where passive products have exploded and are now receiving large inflows. While the big shift to passive investing is yet to play out in South Africa, passive funds are undoubtedly gaining momentum, albeit off a low base, as investors seek diversification at a lower cost.

“In South Africa, where equity market returns have been disappointing over the last five years, investors have acknowledged the need to diversify across asset classes and geographies without jeopardising long-term gains,” says Wehmeyer Ferreira, Executive Director of specialist index tracking provider 1nvest, a collaboration between Standard Bank, Liberty and STANLIB.

Consequently, passive investment products such as Exchange Traded Funds (ETFs) and index tracking unit trusts are gaining momentum as they provide a cost-effective, and efficient way of achieving diversification and reducing overall risk in an investment portfolio.

An affordable avenue to diversification

Much of the argument for passive investing comes down to fees. Because passive funds track a benchmark or index and are not based on a fund manager exercising discretion, they can be delivered at lower fees than actively managed funds. For example, investors can access the 1nvest Top40 ETF for a 0.25% management fee per annum.

“Fees have always been a discussion point, but gained momentum post the Global Financial Crisis (GFC),” Ferreira explains. “The GFC triggered a series of events that put fees under the spotlight. Firstly, it created distrust between institutions that form part of the financial system and the man in the street that buys financial products. Secondly, we entered an environment globally where yields and returns across asset classes were lower than ever before. And thirdly, increased regulation forced more transparency on disclosure, especially around fees.”

These three events were the main drivers behind fee revolutions and the rise of passive funds globally over the last 10-12 years.

Access to different exposures

While the passive investing market is still small in South Africa, the country has experienced a boom in new ETFs and Index tracking unit trusts. Today, investors can choose from a wide selection of ETFs or unit trust that are not limited to equity but provide the opportunity to invest across asset classes and geographies.

1nvest offers a comprehensive range of top-performing, easily accessible ETFs and index tracking unit trusts that investors and their financial advisors can utilise to create or enhance a portfolio. This selection includes funds that provide access to multiple asset classes such as equities, fixed income, property and commodities, in South Africa and offshore.

“With lacklustre returns from the local market and heightened risks to the domestic environment, geographical diversification has become essential. Increasingly, investors are allocating a larger portion of their portfolios to offshore,” Ferreira notes.

It has become much easier nowadays to access offshore markets using index tracking funds. 1nvest’s funds rewarded investors in 2020, with the 1nvest S&P 500 Index Feeder Fund returning 22.33% during the year. The 1nvest MSCI World Index Feeder Fund returned 21.56% while the 1nvest Global Government Bond Index Feeder Fund returned 14.50% during the period.

Ferreira points out that “the passive investment selection comes down to the type of investor, and their individual circumstances. Products range from very well diversified asset class exposure, like the 1nvest MSCI World Index Feeder Fund, to very niche, like the 1nvest S&P500 Info Tech Feeder Fund”.

Globally, in the US specifically, the technology sector has emerged as the dominant driving force behind the performance of equity markets. This is reflected in the performance of the 1nvest S&P 500 Info Tech Index Feeder Unit Trust, which returned 48.31% in 2020.

Investors are, however, not only looking to offshore markets to achieve diversification. “We have seen a marked increase of use of the 1nvest commodity ETFs by our clients wishing to invest and trade precious metals,” Ferreira explains. “We saw more than ZAR22 billion of 1nvest commodity ETFs trade on the JSE by end 2020.”

The 1nvest Rhodium ETF, which is currently the only of its kind on the African continent and one of two in the world, returned a remarkable 187.14% to investors in 2020 – up from 140.9% in 2019. Over the last three years, it delivered an annualised return of 124.96%.

Lowers the risk of underperformance

The shift to passive investing in the post GFC environment, Ferreira says, has been aided by the struggle of active fund managers outperforming the benchmark through a cycle.

“The lack in persistency and predictability of outperformance has created headaches for fund allocators and advisors as they need to spend a disproportionate amount of time reviewing fund managers and performance. There is a realisation that allocating to index tracking products won’t compromise the value proposition to clients and will free up time to focus more on clients and asset allocation.”

This is not to say that there isn’t a place for both active and passive strategies in an investor’s portfolio. “Index exposure can coexist with active funds. Increasingly, clients are adding passive exposure in their portfolios to enhance their overall outcome. This allocation will depend on the person’s individual circumstances, such as investment time horizon and appetite for risk.”

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