Passive investing set to be tested hard when more turbulent markets emerge
Milford Asset Management Portfolio Manager Mark Riggall argues the ‘passive investment’ approach will not handle share
market volatility well and it’s set to be tested hard when more turbulent market conditions emerge.
In an online interview with Ian Fraser this week, he described a ‘passive’ investment fund as “one that invests
passively according to the weight of different shares in a particular index like the NZX50. So, if a share is a 5 per
cent weight in the index, that’s the amount that the fund will invest into that share. There is no analysis of the
quality or value of the companies the passive fund invests into.”
By contrast, an ‘active’ management approach favoured by Milford “means we’re making decisions on a daily basis
regarding which shares, which asset classes and which countries to invest in or not invest in. In a practical sense, it
means we’re aiming to choose those companies that are better value and better quality to deliver the best returns. It
means, for example, investing more heavily in a company like a2 Milk, which has turned into a share market star, while
under-investing or holding very few shares in a company that’s performed poorly - like Fletcher Building.
“Of course, a passive fund will still have a good investment in a2 Milk because it makes up a large part of the index
the fund is aiming to replicate – but it will have a significant investment in Fletcher Building as well, because that
company is also a large part of the index. And not only that but there’s other companies which are potentially even more
risky, such as CBL Insurance which has been suspended because of solvency concerns. We’ve never held a share in CBL but
if you are a passive investor, you will be holding shares in that company.”
Mark Riggall has serious doubts about the ability of the passive approach to weather share market volatility.
“What we saw throughout 2017 was an extraordinary set of conditions where markets were moving higher with very little
volatility, which was the perfect environment for passive investment funds. However, what we saw in February this year
was a bit of a taste of what’s to come.
“We can see that in the past month we’ve had some pretty turbulent markets – some global markets were off 10 per cent or
more. During that period, our active management approach allowed us not only to pick companies like a2 Milk but also at
a portfolio level to protect the funds through insurance, via put options, and also an overweight in cash that allowed
those funds to fall by less than the markets they were invested in. It has delivered better risk and return outcomes for
our investors. The evidence for the success of the approach is that a lot of our investment funds are number one versus
their peers across multiple time frames.
“Up until now, the passive management style hasn’t been tested in a real downturn. When it is, I think we’ll see that
it’s not an approach tailored to trying times.”