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Common Misconceptions about “Passive” Investments
Wealth Life Cycle Investing
Seminar
November 2015
Nerina Visser
ETF Strategist
etfSA.co.za
…it’s just the level of activity that varies
“All Investing is Active”…
Highest costLowest cost
Rules-basedActive Skill
Div+, RAFI, Low volatility,
etc.
Top-down
TraditionalActive Skill- Value Investing- Growth/Momentum- etc.
Bottom-up
Traditional‘Passive’- Market cap
weighted indices(eg S&P500, FTSE100,
Top40, etc.)
Low-churn
Buy & Hold
Passive Dynamic Active‘Active’
‘InnovationCreep’
through‘smart’ indices
& ETFs
You deserve the best
Passive is Average
An ETF is
guaranteed to
underperform the
index, after costsWhy settle for mediocre?
“I’m mediocre…at BEST”
“At least you’reBEST
…at something”
What is average?
Index performance (Weighted) average performance of all shares
Mathematical calculation – costless
Fund / portfolio performance Rand value of all investment holdings + cash distributions
compared to initial investment amount
After all costs incurred to make those investments• Transaction costs
• Administration costs
• Management costs
• Tax implications
-10
-5
0
5
10
15
20
25%
To
tal R
etu
rn p
.a.
All available equity funds
Perception of “average”
Index returnIndex tracking fund return
-10
-5
0
5
10
15
20
25%
To
tal R
etu
rn p
.a.
All available equity funds
Reality of “average”Index return
Index tracking fund return
How Well Do Actively Managed Funds Perform?
% of active managers who failed to outperform their benchmarks (broad-based market index)
1 year 3 years 5 years
USA 86% 76% 89%
Europe 83% 76% 82%
South Africa 84% 82% 85%
Source: S&P Dow Jones Indices (SPIVA Scorecard) (June 2015)
What causes this underperformance?(other than costs)
Size matters!
Investable share universe decreases as fund size increases
If you invest 5% of your fund in 1 company and do not want that own more than 5% of that company:
Fund size R 100 m – 170+ shares to choose from
Fund size R 1 bn – <160 shares to choose from
Fund size R 10 bn – 80 shares to choose from
Fund size R 40 bn – 35 shares to choose from
What constitutes ‘passive’ at the overall portfolio level?
Managing passive building blocks
passively
Managing activebuilding blocks
actively
Managing activebuilding blocks
passively
Managing passive building blocks
actively
Pote
ntia
lto
maxim
ise re
turn
Minimise risk (tracking error)
Comparative Risk and Return Profiles of Passive and Active Strategies
0
2
4
6
8
10
12
14
16
18
0 2 4 6 8 10 12
Re
turn
(%
p.a
.)
Risk (Standard deviation % p.a.)
Historical Performance of Balanced Funds - Medium Equity Mandate
etfSA RA Builder Fund
Actively managed balanced
funds
X: CPI+5
Significant reduction in risk for no sacrifice in
return!
Notes: Average performance for the 10 years from Jan-05 to Dec-14Source: ProfileMedia data; etfSA calculations
ETF vs Index tracking unit trust– clarification of misconceptions
A bid-offer spread is not a cost, and not hidden etfSA investments are done directly with market makers, at
the NAV
There is no such thing as “no admin fee” Beware subsidised cost structures to attract new inflows, with
subsequent increases in costs, or hidden fees elsewhere
Total Expense Ratio (TER) is not the full story This only covers annual / ongoing fees, not regular
transaction costs to invest in underlying assets
Cost Effectiveness of ETFs
Portfolio of Top 40 shares Top40 ETF
Gross investment amount R 100 000 R 100 000
Brokerage (0.5%+VAT) R 570 R 570
JSE fees & levies R 555 R 13
Securities Transfer Tax (STT) R 250
Net investment amount R 98 625 R 99 417
Total cost of investment 1.4% 0.6%
Buying 40 individual shares is MUCH more expensive
than buying 1 ETF unit…
Source: JSE / Strate data; etfSA calculations
*
Portfolio of Top 40 shares Top40 ETF
Gross investment amount R 100 000 R 100 000
Brokerage (0.5%+VAT) R 570 R 570
JSE fees & levies R 555 R 13
Securities Transfer Tax (STT) R 250
Net investment amount R 98 625 R 99 417
Total cost of investment 1.4% 0.6%
* etfSA.co.za brokerage is only 0.08%+VAT
Source: JSE / Strate data; etfSA calculations
0%
20%
40%
60%
80%
100%
R 500 R 1 000 R 5 000 R 10 000 R 50 000 R 100 000 R 500 000 R 1 000 000Tota
l co
st
of
investm
en
t
Investment amount
Top 40 basket Top 40 ETF
Cost Effectiveness of ETFs
… especially if your investment amount is relatively small
12.5% for R5 000!
Source: JSE / Strate data; etfSA calculations
Why not an index tracking unit trust?
0
10
20
30
40
50
60
R100m lump sum 10 x R10m 10 x R1m
To
tal tr
an
sacti
on
costs
(b
ps)
Securities Transfer Tax (STT) Brokerage Statutory charges
The costs of investing daily cash flows are not included in
the TER, but negatively affect
the NAV price
Source: JSE / Strate data; etfSA calculations
Comparison of ETF performance to index-tracking unit trust
1 year performance to 22-Oct-14 – total return
Satrix 40 ETF: 15.78% vs.
Satrix 40 Index Fund: 15.45%
3 year performance to 22-Oct-14 – total return p.a.
Satrix RAFI40 ETF: 10.31% vs.
Satrix RAFI40 Index Fund: 10.07%
Satrix Divi+ ETF: 4.83% vs.
Satrix Dividend Index Fund: 4.67%
Source: ProfileMedia
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Nerina VisserETF Strategist011 274 6173
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Twitter: @etfSA@Nerina_Visser