Blue Chip Issue 90

BLUE
CHIP
INVESTMENT | ETFs
The arithmetic is not in
active funds’ favour
Morningstar reported that a third of European active
equity managers outperformed the average passive
fund in the one year to the end of June 2023.
However, in the last decade, only 17.1% of active
equity and 23.1% of bond managers outperformed their passive
peers, highlighting the compelling value proposition of indexbased
funds. Global fund flows show more investors than ever
are choosing indexation strategies.
Fund flows tell the story
Morningstar makes it clear that while active managers may have
had success recently in the volatile global market, the long-term
picture shows that index funds are more consistent performers. Its
study of almost 26 000 active and index funds indicated that funds’
survival is tied to their success and, typically, index funds outlast
their active counterparts.
Here is further insight into the explosive growth of indexation
or rules-based strategies:
• Over the last 14 years, index-based funds absorbed 65% of net
global flows [1] .
• According to Morningstar, exchange-traded funds (ETFs) in
South Africa now account for 6.3% of market share, and unit
trusts are at 7.5%. Among high equity balanced funds, the assets
under management (AUM) of rules-based or indexed balanced
funds sit at 8.2% but they have attracted an outsized 57.1% of
net flows over the last 12-months within the ASISA South African
Multi-Asset High Equity category [2] .
• Satrix ETF AUM across linked-investment service provider
(LISP) platforms have grown more than six-fold in the past
three years [3] .
The arithmetic of active management
The Arithmetic of Active Management paper by Nobel Prize winner
William F Sharpe shows that for every dollar that outperforms
the market benchmark, another dollar will underperform; it’s a
zero-sum game among all market participants, before costs.
In practice, however, all investing and investment funds incur
costs (from trading and management), which means that the
average fund underperforms the market benchmark, leaving a
minority of funds able to outperform over a given period.
The crux
Active managers’ value should be highest when opportunities to
differentiate are the strongest.
Historically, however, this has not been the case. For a South
African multi-asset manager, the period after 2020 coincided with
a time when getting active calls right was the most profitable
in our history. Despite this, according to Bloomberg and Satrix,
the weighted average 12-month rolling returns of rules-based
balanced funds have outperformed the median rolling returns of
active managers 73% of the time, since 2020. This is also not a new
phenomenon: over the 10 years since the Satrix Balanced Index
Fund’s inception, it has outperformed its active peers over 90% of
the time on a rolling three-year basis.
48 www.bluechipdigital.co.za