Index investing is called ‘passive investing’ as the fund managers of index funds simply buy exposure to the stocks in the market index, a basket of stocks with the largest companies by market capitalisation receiving the largest weights. Examples of market indices are the FTSE/JSE Africa Top 40 index and the FTSE/JSE Africa All Share index. Index tracking funds tend to charge low fees and portfolios earn market returns rather than attempting to outperform the market.

We believe that index tracking strategies should be considered by all investors that seek simplicity, lower investment costs and diversification.

Investors who seek market returns through a simple, transparent and low-cost solution can invest in an index product that meets their financial goals. The cost of managing an index fund is much lower than an active fund, resulting in index investments usually having lower total expense ratios. Over time this fee differential can equate to considerable differences in asset value growth.

Investors who seek diversification from specialised investment products can invest in an index product to reduce total investment risk. Specialised products can include concentrated holdings in individual securities, active manager funds, factor or smart beta strategies, and ETFs that invest in narrow segments of the market. By allocating a portion of their assets in an index tracking solution, investors can reduce their total active risk i.e. the risk that they will underperform the market index. In doing so they will also reduce their total investment costs as index tracking investments usually have much lower costs than other investment products.

Smart beta funds, also called factor funds, are used to capture market characteristics in a transparent and rule-based manner.

A fund that gives the investor the return of a market capitalisation index is referred to as a beta product and is commonly called an index tracker. While beta is exposure to the broad market risk, “smart” beta moves away from market capitalisation weighting to selecting shares according to systematic risk factors. A risk factor is simply the underlying exposure that drives the returns of a market such as momentum, quality, value or low volatility.

Smart beta funds are a valuable complement to portfolios for investors that want to:

  • Access investment characteristics previously only available via active funds
  • Improve the risk-return efficiency of their portfolios
  • Optimise management fee expenditures
  • Improve the liquidity and transparency profile of their portfolio
  • Diversify their existing portfolio allocation

 

Factor or smart beta investments offer investors the opportunity to invest in a particular style or theme they find attractive, for example value, momentum, quality or low volatility.

Investing in these factors generates risk premia, the reward you earn from investing in a systematic risk.

A rules-based factor strategy provides investors with liquid, low-cost and transparent access to systematic risks. This ensures that clients gain consistent and reliable exposure to the factors they desire.

Investors can use these strategies to access uncorrelated returns that can help improve return efficiency, portfolio diversification and volatility management.

Investors have the opportunity to outperform the market index over the longer term. Factor portfolios therefore offer “active-like” returns for “passive-like” fees.

By focusing on the underlying factors that drive risk, return and correlation, factor investing offers more efficient portfolio construction. Diversification by risk factor is expected to grow over the remainder of this decade.

Yes. Active and passive strategies are complementary as finding the right balance between the two strategies can help lower total costs and reduce overall investment risk. Investors with a blend of both active and passive investments have the opportunity to outperform the market index and reduce their total active risk i.e. the risk that they will underperform the market. In doing so they will also reduce their total investment costs as index tracking investments tend to have much lower costs than other investment products.

For an investment to be risk free, the assets of the investment need to have a certain future return. All financials assets therefore carry some risk. An index tracking product that tracks the market will have exposure to market risk. Index tracking products that track factors (like Value, Momentum, Quality and Low Volatility) will have exposure to their respective factor risks, i.e. that the risk that a particular factor is out of favour in the market.

The returns of index tracking products are not guaranteed. The aim of an index tracking product is to replicate the performance of an index, example the market. When selecting a suitable index fund, investors should not only look at the investment fees charged, but also take into consideration the track record of the passive manager in replicating the returns of the index.

An ETF is an Exchange Traded Fund. This is a fund that tracks a market index or a commodity (like gold or oil) or a basket of assets (for example a sector). ETFs are traded like a stock on an exchange and their prices change throughout the day as they are bought and sold.

As an ETF is like a stock bought and sold on an exchange, you will need a brokerage account and to buy and sell through a broker. There may be a commission charge for trading in ETFs.