15 October 2019
Global turbulence and increasing flows into passive investment funds supports “mega cap” stocks and amplifies the risk
of passive investments, Kiwi Invest warns.
Simon O’Grady, Chief Investment Officer with Kiwi Invest, the funds management division of Kiwi Wealth, said Kiwis with
a strong proportion of passive holdings in their investments, including KiwiSaver accounts and many Exchange-Traded
Funds (ETFs), may not fully understand the level of risk they were taking on.
“We believe the best chance for investors to navigate these turbulent times is through an actively managed portfolio.
“Ten years of bull markets had led to a charmed run for passive funds, which many New Zealanders are exposed to via
their KiwiSaver accounts and other investments. However, this performance has masked the risks of passive investing.
“One of the design flaws of passive index investing is their inbuilt tendency to buy more and more of the most expensive
shares as they rise.
“With market conditions becoming increasingly volatile, the risk of a downturn means that passive investors are likely
to be carrying higher risk. Of concern is massive inflows of money via passive funds into mega cap stocks (the largest
listed companies). Many of these stocks are now quite richly valued and face the added risk of flows drying up, yet
passive investors are still buying at a pace.
“Only active managers make an effort to assess the value of stocks and whether they’re worth buying. That’s why we’re
constantly deliberating and considering our positions.
“Good portfolio design should always aim to create the best returns based on risk. To keep risk on target, that means
taking a close look at how risk is spread across shares and a range of asset classes while actively adjusting exposure
to the market through the investment cycle.
“That’s how money is managed smartly.”
Kiwi Invest is not the only fund manager raising concerns about the boom in passive investment.
Michael Burry, the American investor who warned of conditions leading up to the Global Financial Crisis and whose story
was told in the movie The Big Short, says the focus of passive funds on mega cap companies puts downward pressure on the
stocks of smaller companies, creating a “bubble” that could burst.
Kiwi Invest has just released its white paper, The Active Advantage: the case for having your money actively managed,
which assesses the merits of active and passive investment strategies.
The paper found that while passive investment strategies had had a positive effect on lowering management fees
throughout the industry, long-term performance was being compromised. The sole focus on costs, and the level of fee
charged, left money on the table, said O’Grady.
“Passive investment strategies, with their sole focus on costs, miss out on a range of opportunities for adding value to
long-term investment performance.”
The paper also warns investors of the rise of “closet indexers” – where unreasonably high fees are being charged for a
low level of Active Share – and urges investors to ask questions of their fund manager to ascertain a fair fee they
should be paying.
The white paper, including guidance for investors to determine how active their fund is, can be accessed here.
ENDS