Francis Marais – Head of research at Glacier by Sanlam
Where do you see passives adding the most value in portfolios, and why?
Passives are a great way for most investors to access certain risk premia at low cost. In terms of a portfolio context it therefore provides access to “beta” or the systemic return of certain asset classes, or styles, while at the same time reducing overall cost.
Once that foundation is laid you can then choose to add on certain specific alpha sources to achieve your defined outcome and to increase portfolio diversification. These can include managers that are typically very different to the index, concentrated managers, alternative assets such as hedge funds, and specialist or thematic type investments for which passive alternatives do not yet exist.
Fundamentally passives are a great way to offer broad market exposure at very attractive fees.
Are there asset classes where you would never consider using index trackers, and why?
Behavioural finance teaches us that humans aren’t always rational. We suffer from biases in our ability to absorb and interpret information. So there should always be some opportunity for active investing in most markets.
Theoretically, asset classes with lots of information asymmetries – or where there are lots of friction or trading costs when trying to arbitrage inefficiencies away – are characterised by inefficient price discovery and are typically poor candidates for passive investment strategies.
If I had to focus on a particular asset class, I would caution against using pure passives in the fixed income and credit space. This is because there many heterogeneous instruments in this market.
One company may have many different credit instruments outstanding, such as subordinate, secured, floating or fixed, 1-year or 5-year instruments. Some might trade often, and some might not, so pricing these instruments becomes important. Some issues might be offered in large quantities and might be sold directly to the large managers. Others might be sold in smaller batches, benefiting smaller managers as the larger managers might not be interested.
In addition, indices are constructed with weights biased to the largest issuers. Fixed Income is all about optimising between short and long-term rates, credit etc. So, I’m less convinced about passives in this space.
Having said that, using passives in fixed income can still be useful if you have confidence in your expectations. For instance, if you think duration is cheap and offers a lot of value, like it did during March this year, you might feel the need to add duration quickly and cost-effectively to your portfolio by adding a passive fund or ETF that tracks the FTSE/JSE All Bond Index, for instance.