Donald Amstad flags risks of passive investments
Passive management is “positively dangerous” for investors seeking emerging market exposure in Asia, according to an executive from Aberdeen Asset Management.
Speaking at AsianInvestor’s eighth annual Asia Investment Summit in Hong Kong last week, Donald Amstad, business development director, lambasted the idea of using capitalisation-weighted indexes as it exposes investors to an untold number of risks.
“Our point is that whether you take a bond index or an equity index, there are always some very good companies and some very bad companies,” says Amstad. “The idea that we should take money from you and invest in a company that we think is a bad company is something we are philosophically not very comfortable with.”
The risks are more inherent in Asia, as there aren't as many listed companies, which causes severe market-cap overweighting on exchanges. Amstad points to Indian conglomerate Reliance Industrial accounting for 8% of the market cap on the Bombay Stock Exchange (BSE), according to Bloomberg data.
Investing in a market-cap index fund benchmarked against the BSE means it is likely Reliance would be part of the fund’s portfolio, a company that Amstad argues is very risky and in which it has never bought shares.
But when asked by AsianInvestor about the recent growth in smart-beta indices – those built using alternative weighting, such as dividends, which help fund managers avoid exposure to risky assets – Amstad declined to comment.
Arnaud Mounier, Asia chief investment officer at insurer Axa, is more optimistic on smart beta, noting that Axa’s asset management arm launched smart-beta indices earlier this year. “The concept is interesting, and there is much more thinking in generating your portfolio than by the default index construction,” he says.
However, it's important that investors understand how the strategy works, and Mournier notes that as smart beta is a relatively new concept, there are still "large question marks" over how these indices will perform long-term.
Unsurprisingly, Jackson Loi, institutional sales director at index investment specialist Vanguard, took the other side of Amstad's argument and touted ETFs, highlighting cost savings. Compared with the average net expense ratio of 1.80% for Asia ex-Japan active equity funds, passive investment vehicles such as an Asia ex-Japan equity index fund have an average net expense ratio of 0.55%, according to a Vanguard study.
While the expense ratio is easy to calculate, Vanguard notes there are other costs that are more difficult to measure. Higher turnover results in higher transaction costs, such as commissions, bid-ask spreads, market impact and opportunity cost. And because active funds are often involved in frequent transactions as they attempt to outperform the market, their costs are higher. ETFs can avoid these costs, Loi says.
Another important thing to note, Loi says, is that active funds don't necessarily generate better returns. Only one-third of active Asia equity funds outperformed their benchmark over a 10-year period ending September 30, 2011 and remained open over that time, while 32% survived but underperformed, while the remaining 35% closed in that period.
Asked if active fund managers should therefore retire, Loi responded: “No, we don’t think active managers should all retire."
“If the entire market goes passive, the pricing would not be efficient anymore. We do appreciate that active managers want to find value in the industry, but what is important here is that the cost barrier is often too high,” he adds.
Loi suggests that investors take a more balanced approach with index strategies as a core part of an investor’s portfolio, with some exposed to active funds that provide opportunity for alpha returns.
Morningstar data suggests more investors are looking at increase their allocation to passive investments. Passive funds domiciled in Asia experienced net inflows of $16 billion in 2012, more than double the $7 billion that went into non-index funds.
Still, active funds manage significantly more money than passive firms – in 2012, non-index domiciled funds in Asia accounted for 78% of assets, compared with 22% in index funds.
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