Gazette

Considerations with active and passive investments

When making decisions about active and passive investments, it is important to know the difference between the two.

An active approach aims to find opportunities to outperform the market. Skilled asset 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 asset managers find it difficult to deliver on this objective consistently.

A passive approach involves investing in baskets of securities that replicate a market index or benchmark (also referred to as an “index tracker” and Exchange Traded Fund [ETF]), 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 when you can combine the two

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: it is 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 investments in active portfolios reduces costs.

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

Aligned to government’s ongoing retirement reform, fee and cost structures within investments are now clearer and more standardised across investment service providers. Initiatives such as the Effective Annual Costs (EAC) standard, introduced in 2017, enable investors to compare the fees and costs of investment solutions from various service providers. The most recent change became effective from the 1st of March 2019, compelling all 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.

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.

We recommend consulting a financial adviser before making any investment decisions.

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 asset managers, but we believe a portfolio tracking this index will provide a useful diversification for investors seeking to combine active asset 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 (TIC) is expected to drop from the current 80 bps to around 65 bps.

By Hayley Brown, Executive: Business Development at PPS Investments