Comparing apples with apples

Passive funds are all the rage at the moment. But identifying the right manager remains as important as ever, Sanlam Multi Manager International (SMMI) CIO Andrew Rumbelow points out.

“SMMI’s philosophy has always been that you need to make sure you pay for alpha, not beta,” Rumbelow says. In the past, many investors mistook beta for alpha because the variation in returns between different investment biases masked the fact that investors were really just getting the market return (beta) for that specific investment style. “To use the analogy of comparing apples with apples – the first step is to make sure you are, in fact, looking at apples,” Rumbelow points out.

Progress in index tracking means that today you can replicate many of the risk premiums that active managers have exploited in the past through a smart index.  The prevailing wisdom is that if you want a value-bias in your fund, there is no need to pay an active value manager to do this for you.  Simply buy a value-specific index tracker that charges a lower fee.

As it becomes easier to find cheap beta, it becomes increasingly important to know when it is worth paying for true alpha and when you can save on fees by buying cheap beta through an index tracker.  Market cycles will continue. This means that some management styles will continue to fare better at different times.  Identifying the correct strategic tilt and asset allocation in your portfolio therefore remains as important as ever.

Rumbelow points out that SMMI has always held the view that there is room for both active and passive managers in a portfolio.  “Ideally, you want to get your beta as cheaply as possible and then combine this with really exceptional managers who have the best chance of outperforming given market conditions,” he continues.

When looking at managers, the first step is therefore to make sure you are comparing apples with apples.  Are the active managers you are considering all following the same style and are you using the right benchmarks to compare and identify that skill?  Once you are sure that there is an active manager that can deliver outperformance, you need to ask if current conditions favour their management style. “Only then do we ask if it is worth paying more to include that active management skill in our portfolio,” he says.

The fundamental question you should be asking is: what type of beta are you looking for and what kind of alpha? If skill and market conditions are all important when choosing an active manager, then a manager’s ability to track an index and costs are the most important considerations when it comes to passive managers.

“When it comes to passive managers, you are paying for beta, and so you want to make sure you get that as accurately and as cheaply as possible,” Rumbelow points out.  A smart beta product may be more expensive but if it provides access to a specific return profile you are targeting, it may well be worth paying more. “Even with index trackers, it pays to be selective,” Rumbelow continues.  In terms of our analogy, not any old apple will give your portfolio the return profile you seek: it still pays to do your homework when it comes to passive investments.

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