All aboard the ‘passive’ train

Over the past 40 years passive strategies, such as index funds and exchange traded funds (ETF), have steadily gained ground and today make up around 17 % of the global asset management industry. A significant part of the success of passive portfolios is due to their inherent low-cost structure. This means that the overall expenses incurred in managing these types of portfolios are significantly less than their active counterparts.

During 2014, low-cost strategies (passive) attracted nearly 80% of new net flows in the US market. The US is the leading adopter with 24% of all assets invested into passive portfolios. In Europe around 25% of new net flows went into passive strategies. ‘Tax havens’ such Luxembourg, Dublin etc. have seen nearly the same growth as the US market in their overall new net flows. It is interesting to note here that tax havens however have attracted significantly more assets in to active strategies.

In order to understand why passive fund flows into the US markets have differed to those in the rest of the world we need to look at the different categories of portfolios that are being used. The US market predominantly uses equity and fixed interest portfolios which are easy to implement in a passive strategy. European-based clients prefer to use asset allocation (multi-asset) and alternative strategies which are still mostly active portfolios. These clients also make use of portfolios that are domiciled in tax haven regions. It is worth noting that passive multi-asset strategies, such as target date retirement funds are starting to receive attention and they are slowly building up some momentum.

Adoption of low-cost strategies in the SA market

The adoption of low-cost portfolios in the South African market has been a lot slower compared to the US market. Currently just over 3% of total invested assets (excluding life insurance assets) are invested in these strategies. The chart below provides some interesting insight into how South African investors have adopted low cost strategies over the past 18 months. In 2014, the lion’s share of net flows in these types of portfolios went to the multi-asset and the property categories. Low-cost multi-asset portfolios (passive balanced) attracted around 2% of the total net flows in the ASISA Multi-asset categories (income, low, medium and high equity combined) during the year. The momentum seems to be building as the net flows, year-to-date, into multi-asset portfolios are already sitting at R2.5bn!

Role of low-cost strategies in financial and retirement planning[¹]

Over the past few years there has been increased scrutiny and regulation of the services provided by the investment industry, especially around product and advice fees. There has also been a greater awareness among investors around the impact of costs on their long-term savings. These factors are prompting investors to use low-cost strategies within their portfolios to reduce total expenses.

The change in South African retirement regulations which requires member-level compliance with Regulation 28 of the Pension Funds Act has led to most financial plans being implemented using multi-asset portfolios like balanced portfolios. The pressure to reduce costs is therefore leading to a steady adoption of low-cost multi-asset (balanced) portfolios in combination with traditional actively managed portfolios.

There is also a trend among occupational retirement schemes to use retirement solutions which consist of low-cost multi-asset portfolios, low-cost administration and governance (via umbrella funds structures). These solutions aim to remove the complexities that are associated with pension schemes for employers and employees by providing a simple comprehensive low-cost solution[²].

The passive train has indeed arrived     

If the trend in local and global new net flows is anything to go by, we may very well see low-cost portfolios taking closer to 25% of the SA market share in the near future. Passive multi-asset strategies fulfil the need for simple and low-cost portfolios that can be easily incorporated into a financial or retirement plan. This should work in the investor’s favour as reducing costs increases the chances of meeting their long-term investment objectives.

[¹] See ‘A Core-Active™ approach to retirement planning’, Q2 2014 Quarterly newsletter 

[²] The Nedgroup Investments Retirement Solution is such a solution which offers low cost investment fees of 0.35% (excluding VAT) and administration fees of R23.50 per member per month.