TO MAKE South African index funds as attractive as their global counterparts, fund managers need to rethink their pricing model and, in many cases, their business models.
This is the opinion of Tobie van Heerden, Managing Director of 10X Investments.
South African asset managers are lagging behind developed world leaders in terms of moving from actively managed funds to index funds, and South Africa is “the world leader in our financial services industry”, says Van Heerden.
âThe numbers are woefully low,â he says. âIn the investment trust space, for example, only 6% of funds in South Africa are passive. Compare that to the UK, where around 18% of funds are passive. In the institutional space, our numbers are even lower than that, compared to 30% in the UK. ”
Passive funds have also grown rapidly in the US, with over 40% of the market in passive funds, but many will see the UK as a better comparison, due to the so-called tax levy in the US. United.
The slow adoption rate in South Africa comes despite established evidence, both locally and internationally, that passive funds have a compelling investment case in any portfolio.
âThere is no doubt that passive funds should be part of an investment strategy in most cases,â says Van Heerden, who joined 10X after having worked for a long time for Ninety One (formerly Investec Asset Management), where he headed the Middle East and Asia post office in charge of the company’s institutional affairs in South Africa.
He says the main reason for the “disconnect” between the growth of indexation in South Africa and the rest of the world is that the prices of passive investments in South Africa are too high.
âOver the past 20 years, the average total expense ratio on mutual funds, both active and passive, has fallen from 0.93% to 0.41%,â Van Heerden said, referring to Morningstar global figures. âThe average fund commission is 0.62% for assets and 0.12% for liabilities. In South Africa the active funds are around 0.75%, while the passive price is around 0.40% â
He sees two main reasons South Africa’s passive asset management is âtotally out of whackâ compared to the global industry: convoluted business models and a sub-optimal pricing mechanism.
âThe business models for passive gamers in South Africa are convoluted and as a result the fees are not what they should be. The difference between what you pay for an asset and a liability is not big enough for investors.
âWhy should I pay 0.65% for a passive Chinese fund when I can pay 1% or less for an active fund, in an alpha-rich universe. If we can provide 0.20% to 0.25% exposure to China, the discussion becomes different.
âIf you look at the two biggest players in South Africa, one is tied to a life insurer and has to bear high overhead costs, while the other is essentially a multi-manager.
âAt the moment, there is no clear, independent passive house that is big enough to really compete in the market,â he says, adding that the big traditional players are unlikely to lead the way in reducing passive charges.
“If you are sitting in a house where you have significant overhead costs that you have to pay to your mothership, it is very difficult to bring the costs down.”
Ultimately, change will only come when passive funds fundamentally change the way they operate. âA truly independent house must eliminate inefficiencies, must build a ladder, and must have meritocracies in place that allow it to lower costs. Passive play is the winner takes it all.
The other big part of the problem is how the fees are calculated. Van Heerden says it appears fund managers are looking at their competition to determine what the highest price clients are willing to pay. Downward pressure arises when competitors are lower.
Van Heerden argues that the starting point should be: how much does it cost to manufacture these products, and what is a reasonable profit margin?
âIf the fees you get are way above the market, then this is something you are not efficient at and there is work to be done. “
He adds that what has motivated world leaders is efficiency and scale: âThe biggest players take the lion’s share of inflows because they have scale and can aggressively lower their prices. . “