It is amazing how much questionable propaganda and misleading information is still being put out by the financial services industry, while essential facts, particularly relating to risk, are withheld or obfuscated.
Among the worst offenders are the hedge fund and property syndication industries. Both are significantly under-regulated and should be considered fairly high-risk, fringe industries, to be avoided by most ordinary investors.
What is of greater concern is when there are phoney debates about investment vehicles that should be part of almost every investor's portfolio, namely collective investment schemes (see "Online adviser is off track in his comparison").
In recent weeks there has been an artificial debate over unit trust funds versus exchange traded funds (ETFs), most defined as collective schemes in terms of the Collective Investment Schemes Control Act (Cisca).
Passive investments such as ETFs, which track the fortunes of indices such as the FTSE/JSE Top 40 index, are making increasing inroads, albeit still small ones, into the market share of active managers. Also known as tracker funds, they have been late on the investment scene because they have been resisted by South African asset management companies, which are active managers.
Unit trusts and ETFs
Tracker funds come in three different categories:
- Unit trust funds that track an index, such as the Old Mutual Top40 Fund, which tracks the fortunes of the 40 biggest South African companies by market capitalisation (total number of shares issued multiplied by the share price). All unit trust funds are subject to Cisca.
- ETFs that track an index, are listed as shares on a stock exchange, and are subject to Cisca. An example is the Satrix40, which tracks the fortunes of the top 40 JSE-listed companies.
- ETFs that track an index, are listed on a stock exchange but are not subject to Cisca. An example is Absa's NewGold, which does not invest in shares but in bullion. To fall under Cisca, NewGold would have to track the fortunes of gold shares and not own actual gold bars.
Active managers earn their money by claiming that they can add value to your investments over and above what markets provide. Some do it brilliantly, but the overwhelming majority fail to deliver on a consistent basis.
Active managers also create a whole sub-set of people earning money from your investments - from retirement fund asset consultants to linked investment services product (Lisp) companies, which manage administration platforms that allow you to select investments from a wide range of asset managers, through to financial advisers, who, too often unwisely, also play at being asset managers.
So enter passive managers, and whole lot of people stand to lose their jobs, particularly in the asset consultancy business.
Consistently average
The boast of passive managers is that they can provide relatively cheap investments and rid you of the problem of finding a unit trust fund manager who will out-perform the index in the long term.
Or as Brett Landman, the chief executive of Satrix puts it, by investing in an ETF you are being exposed only to market risk and not to active manager risk (the risk of choosing an under-performing asset manager).
He is not saying that you will not find an asset manager who will not beat the average consistently. He is saying that, by using ETFs, you need not seek out that manager.
The entry of ETFs and the launch of unit trust tracker funds have been made easier by active managers generally performing poorly and increasingly pushing up their costs with multiple layering and complex structures, mainly using very misunderstood performance fees.
The debate over passive versus active management is becoming a bit hoary, particularly when those entering the debate get their facts wrong, contradict themselves, disclose selective information or make inappropriate comparisons.
The more constructive debates are about how you can blend active and passive management to your best advantage and how you can minimise costs. These are issues Personal Finance has dealt with extensively, as a search of our website will show.
Indices reflect bundles of securities
An index reflects a combination of investments and is used to give you an idea of how a particular market, such as the JSE, or a sector of a market, such as mining shares, is performing.
In simple terms, an index is constructed by taking account of the value (called the market capitalisation) of the different companies, which is calculated by multiplying the number of shares each company has issued by its share price. Each company or share in the index is then given a proportion of the index in relation to its size. For example, if the total value of a sector is R100 billion and it is made up of 20 companies, with company A's market capitalisation at R40 billion, company B's at R20 billion and the rest making R40 billion, then company A will account for 40 percent of the index and company B will make up 20 percent.
An index-tracking or passively managed investment portfolio simply tracks an index, with money being invested in the underlying shares in the exact proportion as they are in the index.
Online adviser is off track in his comparison
Nick Brummer, a director of a company called Investonline, which describes itself as an online financial adviser for unit trust investments, recently plastered the financial media with an article titled "The truth about the difference between unit trusts and ETFs".
Brummer had no sooner issued the article than he had to reissue it because, to quote him, it "contained some incorrect data".
The incorrect data was that he had got the performance figures relating to the Satrix 40 ETF absolutely wrong. But this was not all he got wrong.
The mere title of his attack is misleading. There cannot be a debate between unit trusts versus ETFs, as he puts it, because passive management is not limited to ETFs. There are also passive investments offered by unit trusts funds.
He should know this if he is giving advice on unit trust funds. He should also know that both unit trusts and most ETFs are governed by Cisca.
The main difference between a unit trust and an ETF as a legal entity is that an ETF is also listed on a stock exchange.
He could present an argument between a unit trust tracker versus an ETF tracker, but he does not do so.
But this is not all that Brummer gets wrong. He is also wrong on a number of other issues.
- Advice.
Brummer argues that ETFs are for experienced investors who have the knowledge to make investment decisions on their own. I would suggest that anyone who has the knowledge to make investment decisions about actively managed unit trust funds would have the knowledge to make decisions about ETFs as well. For those who do not, advice is required to make the right selections.
- Professional management.
Brummer argues that unit trust funds are managed by professionals, who make decisions about asset allocation, cash, currency and aggressive or conservative strategies. All these functions are, however, combined in what is called a balanced or asset allocation portfolio.
Passive funds - both ETFs and tracker unit trust funds - are also managed by professionals; they simply do not employ an army of costly researchers to put together the underlying portfolios. There are currently no balanced ETFs listed. All are asset-class specific.
If you want an asset manager to do the work of blending asset classes for you, then you should select an actively managed asset allocation unit trust fund that includes all the asset classes - shares, bonds, property and cash.
Or if you want to spread your investments across a mix of funds, have a skilled and qualified adviser do it for you, particularly if you want passive funds in the mix.
- Misleading comparisons.
Brummer says that ETFs are often portrayed as providing superior returns to unit trust funds. Apart from again getting the passive versus active argument wrong, I have yet to hear anyone in the passive management field argue that ETFs provide superior returns to all active funds - although they often come close to doing so.
The point made by ETF managers, such as Brett Landman of Satrix and Mike Brown of etfsa.co.za, is that tracker funds consistently provide the return of the market or sector of the market. Tracker funds provide what the market gives. Passive managers and and investors accept that there are star performers, such as Allan Gray, which have consistently out-performed the average over the longer term.
But apples should be compared with apples, not apples with cabbages, as Brummer is doing.
An equity-only unit trust fund should be compared to an equity-only tracker fund. For example, the ETF Satrix Rafi 40, and the passively managed Old Mutual Rafi 40 and Gryphon all share tracker unit trust funds should be compared with the performance of the actively managed general equity funds.
Brummer argues that in the situation where only five out of 47 general equity unit trust funds beat the Satrix 40 over five years to December 2009 this can be explained away. In doing so he presents a number of misleading arguments:
* He says unit trusts hold cash of between zero and 25 percent, which will reduce performance in times of rapid market growth. This is misleading because unit trust funds are not forced to hold high levels of cash; it is the choice of the fund manager. If the fund manager holds 25 percent in cash and gets it wrong, it is simply poor investment decision-making. Incidentally, ETFs also hold cash because you cannot purchase a fraction of a share.
* He correctly says most asset managers consider many indices to be overweight in resources shares relative to other JSE-listed shares, so asset managers go light on resources stocks. This, he correctly says, has caught out many active managers because the resources sector has, over the past five years, provided sound returns.
But, again, active managers are paid to get the asset mix right. Incidentally, just as there are actively managed funds that are light on resources stocks, so there are passive funds such as the Satrix Swix 40, which follows a resources and dual listing adjusted index.
* Correctly, Brummer says some unit trust funds have inflation-plus mandates that will limit returns. But he started off making excuses for general equity funds, and most of the inflation-plus funds are either varied specialist or asset allocation funds. This is another apples and cabbages argument. So this is no excuse for under-performing general equity active managers.
* Brummer claims under-performance can also be attributed to the proliferation of new fund managers, who have "untested processes and limited experience". Well, over the five-year period ending December 2009 to which Brummer refers, the worst performing fund was the inappropriately named Stanlib Prosperity Fund. Stanlib (formerly Guardbank) is one of the oldest active unit trust asset managers. Also around the bottom are other well-known names such as Nedgroup and Momentum. Absa, incidentally, makes it as number one and as number 51.
So what a lot of baloney, Brummer, particularly when you conclude that "by nature ETFs are far riskier than unit trusts and should only be invested in by expert investors". Anyone using Investonline needs to exercise great caution in relation to the advice dispensed and costs.