Article by Satrix Investments

Index tracking as an investment option is equally revered and reviled both locally and globally. The for and against camps are vocal and strident. In a world that is basically polarised about everything these days from politics to gender issues, from Justin Bieber to GM food, we at Satrix strive to always deliver a balanced opinion, while keeping our clients at the centre of what we do. Of course, we believe in and promote index tracking because that is what we do, but we know this is not for everyone and every situation, and it certainly isn’t the panacea to all your investing woes.

So, let’s unpack some myths around index tracking.

Myth 1 – Investing in index trackers is a passive decision

Absolutely not. Any and all investment decisions must be active, deliberate and considered. The moniker ‘simple and transparent’ certainly does not mean ‘needs no thought’. You need to be comfortable investing in equities or the asset class you have chosen. You need to understand the index your fund is tracking. You need to know how your passive choice fits in with your entire portfolio and your goals. Deciding to invest in passive funds is a very active decision.

Myth 2 – You must choose either active or passive investing, not both

Never. Depending on your goals and time horizon, you will need both active and passive investment styles in your portfolio. A well-structured, diversified portfolio can include active and passive investing which apart from tracking market cap indices, also allows you to take advantage of factor exposures. You can use passive funds as the core of your portfolio where you replicate beta (the market) at a lower cost and use truly skilled active managers to add alpha. This is one strategy which could see your portfolio outperform with a guarantee on bringing down costs.

Myth 3 – The South African market is too concentrated to invest in index trackers

The South African market is concentrated meaning only a few companies dominate most of the FTSE/JSE All Share Index. Currently Naspers is the biggest stock at 18% of the index and the largest 10 companies by market cap make up 53% of the index. This is neither a good nor a bad thing. It depends on your investment goals (see Myth 1). If knowing this turns you away from an investment in the Top 40 index, or the JSE All Share, there are many other equity funds to choose from e.g. Satrix Quality, Rafi, Divi +, SWIX or sector specific fund like Satrix Indi, Resi or Fini. The wonderful thing about index tracking is that you are in control of what you invest in.

Myth 4 – Index tracking is deceptively expensive

Again, this is not true. All funds, both active and passive, are legislated to quote fees in many different ways viz. annual management fee, Total Expense Ratio, Total Cost, Effective Annual Cost, performance fees etc. Defining all of these is a thesis on its own, but if you do compare like with like, index tracking will win hands down every time against active managers in the fee department.

Myth 5 – Index trackers uniformly underperform their benchmarks by more than their fees

Once again, not true. An index tracker does need to charge a management fee because despite conjecture, the funds are managed by seasoned quantitative professionals who need to be paid. The index tracking fund also has to incur trading costs in order to replicate the index, but scrip lending can be used effectively to offset some of these costs.  The performance of the fund and the performance of the benchmark should differ by the management fee + portfolio costs. The measure of a truly skilled index tracking manager is to keep this gap as small as possible – this is called your tracking error. Check your index tracking fund, if this is not the case you may want to switch index tracking providers.

Myth 6 – Passive investing is risk-free

The large majority of index tracking products track equity (stock) indices. All stock market investments are risky (i.e. shares and ETFs) because in the short term share prices are determined more by supply and demand than by fundamentals. This causes market volatility. Over time, performance tends to be more a product of the actual value defined in the companies. ETF’s are groupings of these companies governed by the index rules they track. Passive investments have no guarantees and are subject to the vagaries of the market in exactly the same way that actively managed funds are.

Myth 7 – Passive investing is simple

No investing is simple. The choices are complex. They all require a relatively high level of understanding to make appropriate choices and index trackers and all their variations are not different in this respect. Where the simplicity does come in is that you know exactly what you are purchasing and how your fund will change over time because all of this is stipulated in the rules of the index which the fund tracks. This makes it easy to understand the choice you are making (at all times). And via our platform we do make the access to index investing as simple as possible.

By debunking some of the myths about indexing that seem to grow daily, we are hoping to give investors useful and unbiased information with which to make their decisions. The reason we have published this series of articles is to help investors make better decisions and not to confuse them even further.

We hope by holding up as many sides of the story as we can, we are doing just that.

Remember that not doing anything is also an (active) decision.

As always and till next time, #JUSTSTART.

*Helena Conradie is CEO of SATRIX

POSTED : 6 JUNE 2017

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