Many investors are keen to find security in their investments and don’t enjoy seeing their returns eaten up by fees and other costs. That’s why index-linked investments have become increasingly popular around the world.
Index investing is burgeoning, with up to 40% of US assets under management tied to index-linked investment vehicles.
However, Index investing is not yet well understood or hugely popular in South Africa, but this is likely to change as misconceptions and misunderstandings about this investment approach fall away. Index investing in SA is expected to grow from about 11% currently to just over 22% by 2020, according to a Price Waterhouse Coopers report.
Indexes are abstract mathematical measures that track the market as a whole. The idea behind an index investing is that it tracks the performance of the market in your portfolio. Actively managed funds typically charge bigger fees and also offer greater risks, as active investment is a zero-sum game – for every winner there will also be a loser.
However, they are also exposed to greater rewards when a fund outperforms the market or index. Index or passively managed funds, however, are simpler and have historically charged lower fees.
Given the pros and cons of both investment approaches, it makes sense to blend active investment with index-linked investment in your portfolio.
When it comes to choosing an index manager, the trick is to find a fund that matches your tax considerations, liquidity requirements and time horizon, and then to find a manager that has significant assets under management – the bigger the better, as index investing is a low-margin business and more portfolio management fees mean managers can use the latest technology and hire the best people. It’s also wise to consider the track record of the manager.
The length of time a manger has been managing the fund reflects the true risk profile of an investment strategy.
Misconceptions abound with Index investing, the principal one being that these funds are “on autopilot”. This is categorically not the case, as in fact index replication is enormously complicated and requires expertise and experience in trading, risk management and research.
Another misconception is that index investments only really work in developed markets, and that developing or emerging markets require more active management, but there is no evidence to back this theory up.
Old Mutual Investment Group’s Customised Solutions Boutique looks after index investments for its clients, helping investors to blend actively managed and indexation funds to enjoy the security of an index fund as well as the potentially stronger returns of active management.