Picture: THINKSTOCK
Picture: THINKSTOCK

FOR the many clients who placed their hard-earned investments in the care of Coronation Asset Management, the fallout from the collapse of African Bank, and Coronation’s questionable response to it, must have made it very tempting to yank their investments and hotfoot it over to the nearest competitor.

Given that the all share index has returned a client-pleasing 20% over the past 12 months and an astonishing 44% over the past 24 months, passive fund managers that track the index are well positioned to Hoover up those clients who couldn’t keep their nerve.

In their simplest form, indexed funds allocate invested money to individual equities in proportion to the percentage of their market capitalisations. This so-called "investing on autopilot" means clients have a proportionate exposure to the index and as a result their investment will reflect the performance of the market.

It is the simplicity and transparency of this type of investing that 10X CE Steven Nathan says makes passive funds like his so appealing to clients. He says his company provides one simple retirement solution guaranteed to meet the market benchmark.

"If fund managers had conviction about their funds they’d offer you one option, but they don’t. Instead they give you hundreds of complex options that are difficult to understand," he says.

"The result is that the consumer is completely disempowered."

Perhaps more important, Nathan tells me research shows that in the long run, active management seldom outperforms the market and over time investments that track the index stand the best chance of weathering market fluctuations. "Fund managers tell you that you can beat the market, but it’s impossible on average to beat the average," he says.

According to Nathan, the investment industry does an excellent job of highlighting successes while carefully concealing failures. Over the past 10 years, 80% of funds have underperformed, with the result that active asset managers tend to focus on the 20% of their funds that are doing really well.

Moreover, the aggressive marketing campaigns of active asset managers fail to compare the performance of various funds. "Viewed in isolation, a return of 12% over the past year might look like a solid performance but when you compare it with the market return of 20%, there is no comparison."

There are other benefits to the type of investing strategy espoused by 10X: picking one fund and sticking with it means there is less buying and selling, which means lower costs and fewer tax implications. Indexed funds also tend to have lower operational expenses; because trackers often offer fewer products, their assets are usually larger, and larger funds enjoy the benefits of better dealing rates.

The average investor probably couldn’t go too far wrong by adopting this approach. The overwhelming majority of us have not the faintest idea how to navigate the complexities of modern investment markets, or the knowledge to make the right calls at the right time.

Even if we were sensible enough to approach a broker or financial adviser, tied agents — who represent a single company — are limited in the products they can advise on, and the perverse nature of some commission structures means there is an incentive for brokers to change products frequently, to the detriment of their clients’ returns.

The trouble is, most of us would probably like to think we are above average. One of the first questions any financial adviser is likely to ask you before you invest is: "What is your risk profile like?" It goes without saying higher returns usually entail higher risk. Those of us with a gambling streak accept the calculated risk in the hope that we will be the ones to beat the market. And if we don’t beat the market in five years, we should be bold enough to hang on in the hope that the fund we are invested in will beat the market in 10 or maybe 15 years.

Which is what often happens if you do stay the course. According to Louis Niemand, investment director at Investec Asset Management, active fund managers typically do very well over the very long term — at least 10 years.

That is not to say active fund managers are unconcerned about quarterly or yearly performance against the benchmark. Performance at or above the specific benchmark is extremely important for the longevity of their business. Considering that many funds have a notice period of only a few days, or even 24 hours, clients can easily pull their investment.

Another point to consider is that while indexed funds certainly have lower fees than their actively managed counterparts, they still have fees. The result is that there is no way to outperform the market if you track the market. While only 20% of actively managed funds might beat the market over a specified period, 100% of all passive strategies will never beat the market net of fees.

Niemand says active fund managers often struggle against the benchmark when large caps outperform the small and middle caps — as has been happening in the domestic market. This is due to the type of weighting large-cap stocks like Naspers or South African Breweries (SAB) have in tracker funds. The flip side is that active managers also typically do better in bear markets, where they can pick and choose smaller-cap stocks based on value.

But Niemand warns that tracking indices doesn’t come without risks. The weighting of the shares in an index plays a central role in the type of returns you will get and the exposure you have.

For example, the success of the Alsi over the past two years can be attributed almost entirely to a few shares. If you had to remove the effect of the likes of Naspers, SAB and BHP Billiton, the picture would look extremely different. Because the South African market is so concentrated, investing in a so-called safe tracker fund means you are in effect taking some active bets.

Everyone is going to talk their book. It doesn’t matter what your investment philosophy is, I doubt I’d find anyone — at least anyone on record — who’d tell me that their investments are regularly losing money. For this reason, sound financial advice is just as applicable to active investing as it is to passive investing.

We all know we should start investing for retirement as early as possible, and chopping and changing investments is costly. More to the point, any financially literate individual should know the worst time to sell is during a crash.

So whether you choose to invest in indexed funds, or take calculated risks and pick an actively managed fund, it is the quality of the fund manager that really matters.