This article is adapted from a feature on passive investing that originally appeared in the AsianInvestor Spring 2020 edition, published just as the coronavirus was spreading in early March.
The rationale for institutional investors to invest more via passive funds is a simple one: it's very cheap, particularly compared to active fund managers. In many of the more liquid public markets such as US or European large cap equities it has tended to outperform the latter too, especially net of fees.
For many Asian asset owners, and particularly those that have to answer to government departments, this cost efficiency has become increasingly appealing.
“Some investors are extremely fee sensitive. Where this is the case, the handful of basis points paid for passive management are hard to ignore,” said Richard Cooney, a senior investment consultant for Willis Towers Watson.
Shifting from active to passive investing can save a lot. “Our overseas equity management fees in particular were quite high, maybe at 50 to 100 basis points. So by shifting to ETFs maybe we pay one tenth or one fifth of the previous management fees,” Jang Dong-hun, chief investment officer of the Public Officials Benefit Association (Poba) in Korea, told AsianInvestor.
In addition, asset owners who rely on a multitude of fund houses to actively invest can suffer unforeseen issues, said Michele Barlow, head of Asia Pacific strategy and research at SSGA.
“Some clients have upwards of 20 asset managers who manage their international equity portfolio, which can cause some surprising outcomes,” she told AsianInvestor. “For example one client realised its international portfolio was extremely underweight to the US, which meant it underperformed relative to their benchmark.”
Yet aside from a few regional stalwarts, relatively few asset owners in Asia Pacific have fully embraced passive investing.
Just over half of asset owners said they use passive investment vehicles for less than 15% of their assets.
In AsianInvestor's latest quarterly sentiment indicator we asked regional asset owners how much of their portfolio is invested via passive investment vehicles or strategies. Just over half (51%) said they use them for less than 15% of their assets, nearly one third said they do so for 30% or more of their AUM, and just 18% used them for over half.
“In the US roughly half [of equities investing] is passive and internationally it’s about 40%, while it’s much less – sub 20% – for fixed income,” said Jarrad Linzie, head of index research product development at JP Morgan.
This reluctance is hard to pin down, but it likely stems from a traditional belief in the benefits of active investments in the region. It took the US nearly 30 years to embrace the idea of passive investing in its stock market so it’s not entirely surprising that it’s taking Asian asset owners time to reach similar conclusions.
While interest is rising slowly, there are several large users in Asia Pacific.
New Zealand Super is one. Its passive reference portfolio allocates across equity and bonds, and invests about two-thirds of its NZ$47 billion ($30 billion) in assets. The rest the sovereign wealth fund actively invests via an internal team, looking to beat the reference portfolio returns in large part by investing in illiquid assets.
David Iverson, head of asset allocation for NZ Super, says its approach is mostly a recognition that it’s tough for equity fund managers to reliably outperform indices.
“We don’t start with global equities and say ‘we want to be active in that and so how many managers do we hire?’ We don’t have a great focus on active managers as a source of return,” he told AsianInvestor. “In our investment beliefs, we think true skill is reasonably rare. It’s hard to identify and consistently track returns from skill-based sources.
“That’s the way to think about it – not really emphasis on the passive, just not much emphasis on the active.”
Japan's Government Pension Investment Fund (GPIF), another major advocate, uses external fund managers to passively invest about 90% of its equity assets. CIO Hiromichi Mizuno has told AsianInvestor of his disappointment with active fund performance in the past.
However, the world’s largest pension fund, with ¥162 trillion ($1.49 trillion) in assets, is also trying to bring new ideas to bear. It’s planning what it calls a “Index Posting System” (IPS), which it says is “a new framework for collecting index information on a continuous basis”. In essence, the pension fund wants the latest and best index ideas.
GPIF launched the IPS in April this year, after spending the 12 months trialling it. Then it “will begin accepting information for a wide variety of indices based on market cap, smart beta and other themes”.
SSGA’s Barlow said smart beta-type strategies are also gaining traction with other asset owners. “One type proving extremely popular now is minimum volatility strategies, as investors are worried about volatility in the equity markets and how to reduce risk.”
Investment consultants emphasise that diversification across asset classes is the most important factor to secure good returns. However, passive investing plays a role. Where, for example, too little manager diversity can be found, “we would much prefer clients hold passive portfolios,” said Willis Towers Watson’s Cooney.
In addition, some bigger asset owners have little choice but to employ passive investments. “In some cases, [larger sovereign funds’] allocations to home equity markets are in excess of 5% to 10% of the total market capitalisation. Where this is the case, active management isn’t practical,” noted Cooney.
That need is only likely to continue as huge state pensions like Japan's Government Pension Investment Fund, Korea’s National Pension Service or Taiwan’s Bureau of Labor Funds (BLF) continue building their assets. Passive investments offer an easy, market-neutral outlet.
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