Interest in passive or index tracking funds among investors has exploded globally. These funds have gained ground in South Africa too, albeit off a low base, as investors seek greater diversification at a lower cost. Alongside this growth, comes a knowledge gap and this has created misconceptions around index investing.
Some investors believe that passive investing funds like Exchange Traded Funds (ETFs) and Unit Trusts that track the market can never earn inflation-beating returns, for example. Specialist index tracking provider 1nvest unpacks some of the misconceptions to debunk some of the biggest myths around passive investing.
Myth 1: Passive funds don’t beat the market
It is a commonly held belief that because passive investments track the market, they can never earn an inflation-beating return. This is not true, however, because passive investing can entail investing in more than one instrument to get cost-effective market exposure. And the performances of indices differ from country to country, from sector to sector, over different time periods.
If you invest part of your portfolio in the 1nvest Gold ETF, the 1nvest S&P500 Index Feeder ETF and the 1nvest ALSI 40 ETF, then you can invest passively, and your portfolio can beat the broader market. The ETF investments keep investment costs low, and the diversified exposure to commodities, the local and global market, which will allow you to beat the broader market.
Whether taking on an active or passive strategy, or both, individual investors are likely to increase returns by staying invested. Those who get in or out of the market in anticipation of major jumps or drops can find themselves with returns that are much lower than what they would have been if they had stayed invested.
For example, at the onset of Covid-19 when global markets experienced one of the largest crashes in history, some investors panicked and moved and sold their portfolios out at the lowest point in the market. But the correction in global equity markets followed shortly thereafter and those investors then missed out on that bounce back.
Myth 2: Index investing is simple and requires no advice
The truth is there is no such thing as purely passive investing. This myth is driven by the fact that active investing requires a hands-on approach and is managed by a portfolio manager who makes decisions throughout the day. While there is less buying and selling in passive investment, it still requires a hands-on approach to ensure success.
As a financial advisor, there is an active approach which is inherent in passive investing in the form of thorough analysis and research in understanding your client’s risk and return appetite to choose the optimal investment tool for your client. There is no one size fits all solution in passive investing.
Index investing has a range of solutions that blend the best of active with the best of passive investing. Active solutions such as balanced funds use index building blocks but with the objective of providing your client with inflation beating returns in the long term.
Choosing the best product to reach a financial goal is an active act and requires just as much expertise, knowledge, and active advice.
Myth 3: Passive underperforms in times of crisis
There is little evidence, both locally and globally, that passive investing underperforms in times of crisis. Recent statistics from the Association for Savings and Investment South Africa (ASISA) general equity space are revealing.
If you look at ASISA’s SA General Equity performance for the month of March 2020, when Covid-19 really hit equity returns, you see that 60% of managers underperformed against the SWIX ALSI Index and 58% underperformed the 1nvest index fund which tracks the ALSI.
If we extend that period to the first quarter of 2020, which includes a rally and the crash in March then the picture does not change much, with 50% of active funds under performing
We are firmly grounded in research, and our beliefs are derived from the research, with on of our beliefs that its more important to spend time in the market (Beta) than try and pick securities to outperform the market
There are merits for Index funds in emerging and developing markets. In South Africa that merit also exists, and this is true in both equity and fixed income markets. Passive investing requires decision making and making choices for your client, even if you implement by using passive building blocks or solutions.
All of this points to the fact that passive investment tools are integral to developing a comprehensive and effective investment portfolio and should not simply be ignored in emerging markets such as ours.