Why an index fund in SA is not always the best option

By Magnus Heystek – Investment Strategist & Director

OVER the past number of years the popularity of index funds (passive investing) has increased globally, also in South Africa. Proponents of passive fund management, led primarily by companies such as Satrix, initially focused their marketing attention solely on the lower cost structure of index funds versus active managed funds. In the process the inherent risks in index funds were deliberately overlooked or concealed.

Index funds tend to do well in a bull-market when returns are driven by the surge of money flowing into markets and everyone looks good and everyone makes money. It tends to make earning good returns a very simple past-time.

Just buy the index and forget about everything else, was the mantra for a very long time. This claim was advertised-ad-nauseam on radio, public billboards and print advertising. Financial media also fell into the trap of repeating these claims, perhaps under pressure of the massive advertising revenue that comes with these claims. That is, until the market started spluttering and declining and the JSE All Share index started underperforming very poorly in recent years. Then the fault lines in index investing became apparent for all to see.

When last did you see an advertisement trying to convince you to invest in an index fund? To invest in index funds just because they are slightly cheaper than active managed funds overlooks the latent risks inherent in such an index. But as always tends to be the case in the investment world, some of these claims of investment superiority needs to be questioned in greater detail.


Our standard answer for many years has been that (a) we are able to find active fund managers who can beat the index comfortably and (b) that the JSE Top 40 index is not, in our view, the appropriate index for most retail investors in South Africa and (c) at the time we felt the rand was headed for a period of weakness and that offshore funds would do better.

Due to the heavy concentration of resource stocks in the South African economy and hence companies listed on the Johannesburg Stock Exchange (JSE), the resource sector has historically had an inordinate (overweight) loading on the JSE with a very high degree of volatility. When compared to other major indices in other parts of the world, the JSE Top 40 was by far the most volatile and hence unpredictable index.

During the most recent boom in resources stocks, roughly from 2002 to end 2008, the SA Top 40 index did extremely well, but as the share of resources in the index rose year after year (due to resources outperforming banks and industrial companies) the risk also increased substantially.

It was towards the end of 2007 that I found myself in a radio debate on Radio 702 with a spokesman for Satrix who was trying to convince me and the audience that an investment in the Satrix 40 fund was a sound and stable investment. I disagreed and high-lighted the inherent risks that had been building up in the market, and hence the index, at that time.

I would not invest my client’s money into such a risky instrument, I averred on the Bruce Whitfield show. The index contained too many resource counters at the time, a risk which was not highlighted by the marketers of index funds.

These fault lines to which I referred to during the debate have since horribly been exposed over the past five years and in particularly over the last three, as a result of the collapse of resources shares on the JSE. Both the absolute as well as relative performance of the JSE Top40-index over the past 5 years have been very volatile with massive swings in both directions, either up or down.

When one looks at the performance of the JSE All share index over the past five years it reveals a pattern of underperformance (substantial) against global peers (MSCI World Index, for instance) while it also delivered very poor absolute returns, once again due to the large weighting to resource shares, which have suffered a terrible meltdown in values.


Most of our long standing investors know we have been recommending offshore investing for some years now, well before the current bout of weakness and well before it became mainstream advice to diversify offshore.

In this respect our clients have been well served as the performance of an equivalent offshore index (MSCI World Index) at a cumulative return of 180,7% over 5 years, is DOUBLE that of the same investment in the JSE All share index.

Certain country specific-indices such as the S&P500, a broad measure of the performance of the US stock market, produced a return of more than 3 times than that of the local market.

So, investors who did not take their money offshore during this period of time, suffered a substantial relative loss on their local investments versus global counterparts.

The oft-held argument that the JSE gives you off-shore exposure via companies who earn part or all of their income offshore did not hold true, as was often claimed.

The damage to earnings as a result of the resources meltdown plus added negative local factors such as labour unrest and electricity supply issues weighed very heavily on company earnings in SA.

Over a five year period to end June 2016 two balanced funds – Allan Gray Balanced (14,6%p.a.) and Coronation Capital Plus (13,9%) beat the return of 13,6% produced by the JASE All Share, while the Investec Opportunity Fund returned 13.1%, almost matching the return of the volatile JSE All Share Index.

This outperformance is astounding, especially if one considers that balanced funds can only hold a maxi-mum of 75% of its assets in equities or property, but it was the ability to hold offshore assets that boosted returns substantially.

What is important is that these returns were produced at a volatility (deviation from mean) of HALF that of the JSE All Share index. This factor is sometimes overlooked when investment returns are analyzed.

Over the five year period in question the JSE ALSI has experienced significant volatility and massive draw-downs of up to 18% from peak to trough. Such periods of sharp declines in investment values often leads to emotionally induced reaction from investors, either withdrawals or switches into other asset classes.




Over a four year-period the cumulative performance of the JSE All Share versus five balanced funds mainly used in our portfolio construction looks as follows: Allan Gray balanced (63,2%), Coronation Balanced Plus (57,1%), JSE All Share Index (54,4%), Coronation balanced 44,2%) and Stanlib Balanced Fund 43,8%).


Over 3 years the same comparison looks as follows: Allan Gray (45,4%), JSE All Share (43,5%), Investec Opportunity (39,5%), Coronation Balanced(37,9%), Counterpoint Balanced (31,3%) and Standard Balanced (30,6%).


It’s over the past two and one years that the comparative investment returns diverged substantially. The cumulative performance over 2 years shows the Investec Opportunity Fund (20%) and Allan Gray Balanced (19,3%) returning more than double the return of the JSE All Share index which returned a mere 8,1% over the same period of time. The other three funds (Coronation Balanced (12,8%), Counterpoint Balanced(10,4%) and Stanlib Balanced (10,4% beats the volatile JSE All Share over the same period of time.


Over a one year period the comparison looks even worse. The JSE All Share (2,8%), lagging far behind Investec Opportunity (15,4%), Allan Gray Balanced(14,9%), Counterpoint (6,7%), Stanlib Balanced (5,1%) and Coronation Balanced (3,5%).

SUMMARY: We often find that investors are influenced by biased advertising, based on short-term trends. The same applies to other fads such as dieting and medication, for instance. But nothing replaces independent and objective research and analysis to show up the short-comings of such a superficial approach to investing.

Do not hesitate to contact any of our investment advisors if you have any more questions or wish to discuss your investment strategy.

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