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

Contact Details

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Discretionary Investments 0861 383 721 info@etfsa.co.za

Tax Free Investment Accounts 0861 100 917 etfia@computershare.co.za

Retirement Annuity Funds 0861 383 727 rafunds@etfsa.co.za

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Portfolio Management Service 011 274 6174 portfolios@etfsa.co.za

Mike BrownManaging Director011 274 6171mikeb@etfsa.co.za

Nerina VisserETF Strategist011 274 6173

nerinav@etfsa.co.za

Websites: www.etfsa.co.zawww.etfsara.co.za

Twitter: @etfSA@Nerina_Visser