Passive goes active… News Flash, Dynasty Asset Management

Ever since passive investing vehicles started to gain traction with their share of the US domestic equity fund market overtaking active funds in or around August 2018 – some fund managers and analysts have suggested that active funds are about to come into their own again.

BlackRock, the world’s largest asset manager, just this week suggested that current macroeconomic conditions favour active funds over passively managed funds. Its paper referred to a “new regime” in which interest rates are set to stay high for longer compared to the past era of low interest rates, creating circumstances in which active fund managers could thrive.

Geopolitical uncertainty and sticky inflation could also play to the strengths of actively managed funds in BlackRock’s view. The report from BlackRock has made the investment community sit up and pay attention because the asset manager has profited handsomely over time from the shift towards passive vehicles such as exchange-traded funds.

If BlackRock is correct, it would mark a significant sea change. Even in the face of market volatility, active funds have, on average, underperformed index trackers in recent years. Most active funds missed out on both the energy and commodities boom of 2021 and 2022, and then were underweight on the Magnificent Seven tech stocks that drove the broad index gains of 2023.

Back in 2017, we took a look at the passive versus active debate and outlined our strategy of balancing active and passive funds in our client portfolios. We believe our approach is still valid, especially in terms of the benefits of passive funds in delivering good returns without the high fees of active fund managers.

With the debate resurfacing, there are, however, a few points worth noting. Not all active funds are created equal. It goes without saying that most active funds will deliver average or subpar returns relative to their benchmarks over time, and that only a small percentage will consistently approximate or outperform their benchmarks. Many of them, in benchmarking themselves against an index, will build a portfolio that comprises many of the same underlying assets as their benchmark. This makes it hard for them to outperform.

Active funds may also have vastly different investment philosophies but with exactly the same benchmark, which will yield divergent performances depending on market conditions. For example, some focus on buying quality companies with predictable and consistent earnings, while others focus on trying to identify deeply undervalued businesses. (Our preferred actively managed funds – Ninety One Global Franchise and Fundsmith Equity – have a bias towards quality and both have outperformed their benchmarks since their respective inception dates.)

Additionally, the lines between passive and active investment are not always that clear cut. Switching between different passive vehicles to achieve higher growth or reduce risk is, in itself, an active decision.

We agree with BlackRock’s analysis that the gap between winning and lagging stocks has widened since 2020, creating a bigger opportunity for active managers to beat broad market returns. Furthermore, the heavy weighting of the Magnificent Seven in the indices means that concentration risks are high in the event of a correction in Big Tech valuations.

Where we differ is that we regard it as nearly impossible to get the timing right in switching between different funds and vehicles in pursuit of the highest possible growth. A carefully selected blend of active and passive vehicles (without trying to time switches) is – in our view – a more defendable approach in constructing clients’ portfolios and may be particularly relevant in the current investment environment.

“Static asset allocations — or set-and-forget portfolios — are a reasonable starting point, but we don’t think they will deliver as in the past.”

– Vivek Paul and Andreea Mitrache -BlackRock Investment Institute analysts

“Most active investors fail to realise that they are part of the crowd themselves. They are trying to beat the crowd while being the crowd”

– Naved Abdali, author of Investing – Hopes, Hypes, & Heartbreaks

Global News

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The US economy grew at an 3.2% annual pace from October through December, propelled by healthy consumer spending the Commerce Department reported Wednesday in a slight downgrade from its initial estimate. The economy grew 2.5% for all of 2023, topping the 1.9% growth in 2022.
The US House reached a last-minute deal on Wednesday to avoid a disruptive US government shutdown, triggering fresh opposition from hardline Republicans. The agreement entails temporary funding for one week, forestalling a partial shutdown scheduled for March 2, and ensuring funding for select government functions until September 30. The rest of the US government, including the Defense and Homeland Security departments, still faces a potential March 23 shutdown.
US inflation increased in January as expected, but the annual increase in inflation was the smallest in nearly three years, keeping a June interest rate cut from the Federal Reserve on the table. According to the Commerce Department’s Bureau of Economic Analysis, the US’ Personal Consumption Expenditures price index, which excludes energy and food was up 2.4% for the 12 months to January, a slowdown from December’s 2.6% increase and represented the smallest year-on-year increase since February 2021.
Economists have again marked down US recession forecasts on expectations that a firm job market and sturdy consumer spending will support stronger economic growth in the near term. The economy is seen as expanding at a 2.1% annualised rate this year, up from a forecast of 1.5% survey result last month. This is due to stronger household demand and government spending, according to the latest Bloomberg monthly survey of economists.
However, Goldman Sachs Group CEO David Solomon said softer spending by consumers calls into question expectations that the US economy will avoid a recession. He believes that the world is set up for a soft landing, and that investors will keep repositioning their funds in a slower economy.
The US currency is just shy of the record it reached during the pandemic and is on pace for its best year since 2020. As measured against the currencies of America’s largest trading partners, it’s 17% above its average over the last two decades.
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A wild 24 hours for the cryptocurrency market saw Bitcoin jump as much as 13% on Wednesday to $63,968, its first trip above $60,000 since November 2021. It has lost some of the gains to trade at $61 958 as of 1.30 pm today.
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As at Thursday’s close the S&P 500 was 0.15% up for the week.

Local News

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South African Revenue Service commissioner Edward Kieswetter has agreed to extend his term by a further two years, helping to ensure leadership continuity and cement the turnaround at the tax authority. Kieswetter separately said the use of AI and proactive measures resulted in the recovery of R210 billion for the first 11 months of the current tax year. There is currently R300 billion owed to SARS.
Sasfin Bank has received a civil summons from SARS for a staggering R4.9 billion plus interest and costs, in a novel lawsuit that tests the tax collection agency’s boundaries. The niche lender, that caters for small and medium-sized businesses, has rejected the claim as baseless. The claim hinges on SARS’s alleged inability to collect taxes and penalties from former foreign exchange clients of the bank who were involved in a criminal syndicate that colluded with some of the bank’s employees to expatriate money illegally.
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At the time of writing the rand was 0.85% stronger against the USD and the ALSI was down 1.9% for the week.