There is no such thing as passive investing, delegates at the portfolio institutional passive investment conference heard.
“There is no such thing as passive management. We are passively allowing the rules to continue, but there has been an active decision before you got there.”
Andrew Clare
Keynote speaker Andrew Clare, associate dean at Cass Business School, had the PI staff shooting each other confused and panicked looks when he kicked-off the conference by declaring passive investment, the subject of the entire event, did in fact not exist.
Clare said: “It is not good to kick off a conference on passive investing by saying, ‘actually there is no such thing as passive investment,’ but it is absolutely true.”
He added: “What we are actually doing is passively allowing the rules to continue, but there has been an active decision before you got there. The active decision is that one investment strategy is preferable to an infinite number of others.”
Clare explained defining passive investment came down to the distinction between rules and discretion, a gap which over the last 10 years the industry had tried to fill with an increasing range of products, from capweighted at one end to active benchmarks at the other.
“What distinguishes each one is the degree to which rules or discretion play a role in each one,” he said. “But that’s it, there is no such thing as passive.”
Clare said one of the “main and valid criticisms” of market cap indices was certain stocks’ weightings tended to be too high.
He said: “If you talk to trustees and say ‘Do you know you have a 10% weight in BP? Is it because you think it will outperform best?’ and they say, ‘No, just because it’s 10% of the index’. On that basis it does not seem like a smart way to invest, but the pros far outweigh the cons and getting asset allocation right is by far the most important decision.”
Clare illustrated the point by alluding to research conducted by Cass which found an index of US stocks created by applying the rules of Scrabble comprehensively outperformed a market-cap index over a 46-year period.
The results showed by the end of 2014, $100 invested at the end of December 1968 in the market-cap portfolio would be worth $7,718, but when invested in the Scrabble-weighted portfolio would be worth $14,108, almost double the benchmark.
“It makes market cap look pretty poor as a strategy,” said Clare.
Delegates also heard how smart beta was an effective investment solution but was blighted by complexity and getting the timing of entry right.
Intech senior managing director Carl Moss said smart beta offered low fees and the prospect of better-thanmarket performance, but added he was concerned whether managers were doing the education job they should.
“Some of these strategies are really quite complicated even though they are presented as semi-passive approaches,” he said. “There is a lot going on under the surface and it is worthwhile to know something about that because it gives you some feeling for when it is and when it isn’t going to work.”
Islington Council pension fund subcommittee chairman Richard Greening agreed complexity was an issue, but added there was also a critical question around how to time entry into these strategies.
He said: “Think about when exactly you want to move because there can be good or bad times because any change will incur significant transition costs, which is something that is largely ignored when ministers instruct us to all form very large pools over night.”
Redington senior vice president, manager research, Aniket Das said investors were investing in core developed markets passively, but accessing little niches such as emerging markets and small cap on an active basis.
“Certainly people feel [active managers] have better picking capability in these niches where there are certainly less managers,” he said. “There is a thesis it should be easier to outperform in these niches than across broad market indices which are well covered.”
Elsewhere, delegates heard how it was important to decipher between two types of smart beta strategies: those which specifically exploit a particular group of factors such as small cap or value and growth; and those which alter portfolio construction slightly to deviate away from traditional market cap.
The panel, which included Buck Consultants CIO Simon Hill, Amundi global head of index and smart beta Laurent Trottier (below) and UBS index analyst Boriana Iordanova, also discussed how investors should view an allocation to smart beta in the context of the portfolio as a whole, not just against their equity allocation.
During another panel discussion (pictured below), ETF Securities product strategy director Michael Langerup, Towers Watson investment director Phil Tindall and Rentokil Initial head of treasury James Kelly debated the pitfalls of fixed income indices including that the most indebted companies have the biggest weighting.
Langerup said the exchange traded fund (ETF) industry was innovating to include strategies that wrap factors such as fundamentally- weighted stocks into an ETF wrapper. Kelly said the more obscure the investment, the less commoditised it was which made it difficult to access alternative asset classes passively. He said there needed to be market makers for the sector like those found in the equity world. Tindall meanwhile, said there were hedge fund-like strategies such as carry/value which use a long/short format being offered by some banks.
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