The document discusses implications for South African investors of significant changes affecting the investment landscape. It summarizes that over the last 10 years, most active equity managers in South Africa have underperformed the market index, though some have used large marketing budgets to retain investors. Regulatory changes and cost pressures are now driving many investors toward index funds. Behavioral biases still cause some investors to prefer active managers, choosing those with recent strong performance, but studies show manager performance is generally not persistent and indexing provides better returns over the long run.

1. IMPLICATIONS FOR INVESTORS OF SIGNIFICANT
CHANGES EFFECTING THE SA INVESTMENT
LANDSCAPE
March 2016
John Gilchrist
“THE ASSET MANAGER HAS NO
CLOTHES!”

2. “THE ASSET MANAGER HAS NO
CLOTHES!”
Source: https://www.youtube.com/watch?v=dSWVXNtI0SU |Kim Parkhurst
2

3. AGENDA
 Introduction
 The Global Experience
 The SA Experience
 Why do people still choose active managers?
 How are investors reacting to these changes?
 What should you do?
3

4. INTRODUCTION

5. THE EMPEROR’S NEW CLOTHES
HANS CHRISTIAN ANDERSEN (APRIL 1837)
Source: https://www.youtube.com/watch?v=dSWVXNtI0SU |Kim Parkhurst
5

6. THE ASSET MANAGER HAS NO CLOTHES!
■ Globally active equity asset managers’ under-performance has led to a significant increase in
indexation investing
■ In SA active equity managers (fundamental stock-pickers) have generally performed better than their
offshore counterparts, and have used this (plus huge marketing budgets) to create a stranglehold on
the market
■ Over the last 10 years, performance by most active equity managers has been poor; the last 5 years
has been extremely poor – belief in these managers has been shaken
■ Regulatory changes & cost pressures are simultaneously driving many investors away from active
equity managers:
− Retail Distribution Review – greater cost transparency
− Proposed changes to default retirements funds - preference for indexation investing
■ We examine the implications for investors of this significant & ongoing change in the SA investment
landscape
6

7. THE GLOBAL
EXPERIENCE

8. PERFORMANCE OF U.S. EQUITY MANAGERS
CONSISTENT & SIGNIFICANT UNDER-PERFORMANCE, EVEN BEFORE FEES
0%
2%
4%
6%
8%
10%
12%
14%
12 Months 3 Years 5 Years 10 Years
Return(annualised)
Annual average return: Index Funds vs Non Index Funds
US Non Indexation Funds
US Indexation Funds
Source: Bloomberg (net of fees)
8

9. PERFORMANCE OF U.S. EQUITY MANAGERS
CONSISTENT & SIGNIFICANT UNDER-PERFORMANCE, EVEN BEFORE FEES
Source: SPIVA US Scorecard – mid year 2015
9

10. SIGNIFICANT GROWTH IN INDEXATION STRATEGIES
Indexation
17%
Non
Indexation
83%
Aug 2010
Source: Bloomberg
Indexation
23%
Non
Indexation
77%
Aug 2015
■ Indexation / passive investing has continued to grow across the world
10

11. SOURCES OF ALPHA
RESEARCH IS DEMYSTIFYING ALPHA & REVEALING MUCH OF IT IS DUE TO FACTOR
EXPOSURE
Smart Beta
Re-defining alpha:
Equities: Consistent
Biases
Source: Eugene Fama and Kenneth French, The Cross Section of Expected Stock Returns, Journal of Finance, June 1992; Mark Carhart, On Persistence of Mutual
Fund Performance, Journal of Finance, March 1997; Robert Novy-Marx, The Other Side of Value: The Gross Profitability Premium, Journal of Financial Economics,
April 2013.
Robert
Novy-Marx
Indexation
Equities: Adaptive Biases
Hedge funds &
11

12. ACCESSING SOURCES OF EXCESS RETURN
0
2000
4000
6000
8000
10000
12000
14000
16000
18000
20000
Dec-74
Apr-76
Aug-77
Dec-78
Apr-80
Aug-81
Dec-82
Apr-84
Aug-85
Dec-86
Apr-88
Aug-89
Dec-90
Apr-92
Aug-93
Dec-94
Apr-96
Aug-97
Dec-98
Apr-00
Aug-01
Dec-02
Apr-04
Aug-05
Dec-06
Apr-08
Aug-09
Dec-10
Apr-12
Aug-13
Dec-14
USA GROWTH USA RISK WEIGHTED USA VALUE USA
■ Ability to capture sources of excess return (including value, momentum, size & quality) through lower
cost smart beta strategies has been welcomed by the market
MSCI Factor returns
12

13. ACCESSING SOURCES OF EXCESS RETURN
■ Similar to indexation, smart beta has grown substantially over the last 5 years in particular
Global assets in smart beta strategies
Source: Morningstar Direct, Morningstar Research13

14. THE SA
EXPERIENCE

15. PERFORMANCE OF SA EQUITY MANAGERS
Source: Morningstar, Old Mutual Investment Group
■ Average equity fund has lagged the index by 2.4% pa over the last 10 years
15
13.7% p.a.
11.3% p.a.
0
50
100
150
200
250
300
350
400
450
Feb-06
Jun-06
Oct-06
Feb-07
Jun-07
Oct-07
Feb-08
Jun-08
Oct-08
Feb-09
Jun-09
Oct-09
Feb-10
Jun-10
Oct-10
Feb-11
Jun-11
Oct-11
Feb-12
Jun-12
Oct-12
Feb-13
Jun-13
Oct-13
Feb-14
Jun-14
Oct-14
Feb-15
Jun-15
Oct-15
Feb-16
CumulativeReturn
JSE SWIX Index
(ASISA) South African EQ General Peer Average

16. PERFORMANCE OF SA EQUITY MANAGERS
Source: Morningstar, Old Mutual Investment Group
■ The bulk of active equity managers consistently under-perform the index
16
45%
38% 34%
26%
42%
14%
55%
17%
48%
55%
62% 66%
74%
58%
86%
45%
83%
52%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2007 2008 2009 2010 2011 2012 2013 2014 2015
1 Year Return Periods - SWIX relative to General Equity Peers
% of Managers outperforming SWIX % of Managers underperforming SWIX

17. PERFORMANCE OF SA EQUITY MANAGERS
Source: Alexander Forbes survey data – January 2016
17

18. PERFORMANCE OF SA EQUITY MANAGERS
■ Does this under-performance really surprise anyone?
− Fundamental equity performance is driven by correctly predicting currency moves & commodity price moves &
interest rate moves & political moves & central bank actions & random events & group behaviour & …
simultaneously & on an ongoing basis
Source: http://richtopia.com/guidance-opinions/throw-out-your-crystal-ball
18

19. “STATE OF SA ACTIVE EQUITY MARKET”
Source: https://www.youtube.com/watch?v=dSWVXNtI0SU |Kim Parkhurst
19

20. GROWTH IN SA INDEXATION EQUITY STRATEGIES
0
1000
2000
3000
4000
5000
6000
7000
8000
Aug-05
Nov-05
Feb-06
May-06
Aug-06
Nov-06
Feb-07
May-07
Aug-07
Nov-07
Feb-08
May-08
Aug-08
Nov-08
Feb-09
May-09
Aug-09
Nov-09
Feb-10
May-10
Aug-10
Nov-10
Feb-11
May-11
Aug-11
Nov-11
Feb-12
May-12
Aug-12
Nov-12
Feb-13
May-13
Aug-13
Nov-13
Feb-14
May-14
Aug-14
Nov-14
Feb-15
May-15
Aug-15
Cumulative Growth in unit trust assets
Indexation Funds
Non Indexation Funds
Approximately 51% pa
growth in indexation
funds
Source: Morningstar
■ Percentage growth in indexation assets over the last10 years has been impressive
20

21. GROWTH IN SA INDEXATION – CLOSING THE GAP
98.99%
1.01%
Unit trusts: Indexation vs Non Indexation
Aug 2015
Non Indexation Funds
Indexation Funds
76.7%
23.3%
Unit trusts: Indexation vs Non Indexation
Aug 2020
Non Indexation Funds
Indexation Funds
An 80% p.a. increase in the
size of passive investments
would result in the following
split by Aug 2020
Source: Morningstar
■ Despite significant growth (off a very low base), SA usage of indexation investing lags the rest of the
world dramatically
21

22. WHY DO PEOPLE
STILL CHOOSE
ACTIVE
MANAGERS?

23. “BEHAVIOURAL BIASES DISTORT OUR PERCEPTION OF
REALITY”
Source: https://www.youtube.com/watch?v=dSWVXNtI0SU |Kim Parkhurst23

24. INVESTORS’ 10 MOST COMMON BEHAVIOURAL BIASES
■ Confirmation bias
■ Optimism bias
■ Loss aversion
■ Self-serving bias
■ Planning fallacy
■ Choice paralysis
■ Recency bias
■ Herding
■ Preference for stories over analysis
Source: https://rpseawright.wordpress.com/2012/07/16/investors-10-most-common-behavioral-biases/
Behavioural biases that support investing with fundamental equity managers (even
though data shows they under-perform on average) rather than indexation funds
24

25. EXAMPLE: BEHAVIOURAL BIAS
Who believes they are a worse than
average driver?
25

26. CAN INVESTORS’ SUCCESSFULLY PICK ACTIVE
MANAGERS?
■ Once again, the behavioural biases come into play when choosing which fundamental managers to
invest with, but the following biases are key:
− Recency bias
− Herding
− Preference for stories over analysis
■ Money flows to managers with the best stories / marketing who have performed well recently & who
other people are investing in
■ Let’s examine the impact of choosing fundamental managers in this way …
26

27. RECENCY BIAS – PERSISTENCY OF PERFORMANCE
■ While studies agree that active funds under-perform indices by a significant margin, results on the
persistence of performance are less clear cut …
■ Long term winners can become medium & short term losers
Source: OMIG, unit trust performance data – September 2015
Fund 1 year 3 years 5 years 10 years
Quartile Quartile Quartile Quartile
ABSA Select Equity 3 3 3 1
Allan Gray Equity A 3 2 2 1
Coronation Equity R 3 1 1 1
Coronation Top 20 A 4 3 2 1
Foord Equity R 2 1 1 1
Investec Active Quants A 3 2 2 1
Marriott Dividend Growth R 1 2 1 1
Nedgroup Inv Value R 2 3 3 1
Old Mutual Investors R 1 1 1 1
Old Mutual Managed Alpha Equity A 1 1 1 1
Prudential Dividend Maximiser A 3 2 2 1
Prudential Equity A 3 2 1 1
SIM General Equity R 2 1 1 1
27

28. RECENCY BIAS – PERSISTENCY OF PERFORMANCE
■ The market environment constantly changes & manager style drift over time can occur, distorting any
meaningful analysis on persistency …
■ 3-year data appears to show some persistence, but 5-year data is inconclusive
Source: OMIG unit trust performance data – September 2015
3 Year 3 Year
Quartile Quartile
Today 3 years ago
ABSA Select Equity 3 1
Coronation Equity R 1 1
Coronation Top 20 A 3 1
FG IP Mercury Equity FoF A1 3 1
Foord Equity R 1 1
Gryphon All Share Tracker 2 1
Harvard House BCI Equity 1 1
Imara MET Equity 1 1
Investec Active Quants A 2 1
Marriott Dividend Growth R 2 1
Momentum Best Blend Specialist Eq A 1 1
Nedgroup Inv Value R 3 1
Old Mutual Managed Alpha Equity A 1 1
Prime General Equity B 1 1
Prudential Equity A 2 1
Sasfin MET Equity A 1 1
STANLIB Equity R 2 1
STANLIB MMAll Stars Eq FoF B1 2 1
STANLIB SA Equity R 3 1
Stewart MET Macro Equity FoF A 2 1
5 Year 5 Year
Quartile Quartile
Today 5 years ago
ABSA Select Equity 3 1
Allan Gray Equity A 2 1
Coronation Equity R 1 1
Coronation Top 20 A 2 1
Flagship IP Equity A1 4 1
Foord Equity R 1 1
Investec Value R 4 1
Kagiso Equity Alpha 3 1
Nedgroup Inv Value R 3 1
Prudential Dividend Maximiser A 2 1
Prudential Equity A 1 1
SIMGeneral Equity R 1 1
SIMValue R 3 1
28

29. HERDING
■ We know that significant flows can positively impact active managers’ performance
− These flows can create an under-pin to the share prices of the managers’ favourite / overweight shares
− This is possibly a contributing factor to inconclusive persistency data
■ Successful strategies (& related share picks) are also sometimes copied by competitors, creating
further support
■ However, as assets under management increase, the ability to generate excess returns declines:
Portfolio Size
(R’ billions)
# of shares
which can be
held
10 157
25 135
50 103
100 80
200 57
Source: Old Mutual Investment Group, Peregrine – max 5% of a share & minimum holding 0.5% of portfolio
This naturally
results in
manager style
drift as assets
increase
29

30. HERDING
VICTIM OF SUCCESS – ALLAN GRAY
Source: Morningstar
30
R 0
R 5,000
R 10,000
R 15,000
R 20,000
R 25,000
R 30,000
R 35,000
R 40,000
R 45,000
R 50,000
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
Feb-07
May-07
Aug-07
Nov-07
Feb-08
May-08
Aug-08
Nov-08
Feb-09
May-09
Aug-09
Nov-09
Feb-10
May-10
Aug-10
Nov-10
Feb-11
May-11
Aug-11
Nov-11
Feb-12
May-12
Aug-12
Nov-12
Feb-13
May-13
Aug-13
Nov-13
Feb-14
May-14
Aug-14
Nov-14
Feb-15
May-15
Aug-15
Nov-15
Feb-16
Rand(millions)
1YearRollingAlpha
Allan Gray Equity A (CIS) vs JSE All Share Index
1 Year Rolling Alpha AUM

31. HERDING
VICTIM OF SUCCESS – ALLAN GRAY (CONTINUED)
Source: Morningstar
31
R 0
R 5,000
R 10,000
R 15,000
R 20,000
R 25,000
R 30,000
R 35,000
R 40,000
R 45,000
R 50,000
0%
2%
4%
6%
8%
10%
12%
14%
16%
Feb-07
Jun-07
Oct-07
Feb-08
Jun-08
Oct-08
Feb-09
Jun-09
Oct-09
Feb-10
Jun-10
Oct-10
Feb-11
Jun-11
Oct-11
Feb-12
Jun-12
Oct-12
Feb-13
Jun-13
Oct-13
Feb-14
Jun-14
Oct-14
Feb-15
Jun-15
Oct-15
Feb-16
Rand(millions)
TrackingError
Allan Gray A (CIS) vs JSE All Share Index
1 Year Rolling Tracking Error AUM

32. HERDING
FUTURE VICTIM OF SUCCESS – CORONATION?
Source: Morningstar
32
R 0
R 1,000
R 2,000
R 3,000
R 4,000
R 5,000
R 6,000
R 7,000
R 8,000
R 9,000
-15%
-10%
-5%
0%
5%
10%
15%
20%
Feb-07
Jun-07
Oct-07
Feb-08
Jun-08
Oct-08
Feb-09
Jun-09
Oct-09
Feb-10
Jun-10
Oct-10
Feb-11
Jun-11
Oct-11
Feb-12
Jun-12
Oct-12
Feb-13
Jun-13
Oct-13
Feb-14
Jun-14
Oct-14
Feb-15
Jun-15
Oct-15
Feb-16
Rand(millions)
Alpha
Coronation Equity R (CIS) vs JSE All Share Index
1 Year Rolling Alpha
AUM

33. PREFERENCE FOR STORIES OVER ANALYSIS
■ Fundamental managers tell great stories, both ito the macro picture & when it comes to individual
shares
■ Certain types of stories resonate with certain investors / consultants
■ We have seen this result in disastrous over-concentration of investments with managers who adopt
the same investing style
− Over-concentration with value investors over the last 5 years is a classic example
■ Fundamental managers also like to use fear to support their arguments, painting indexation or
smart beta strategies as “ships without a captain, unable to steer away from rocks”
− Long term return number show that this argument is not valid
− African Bank shows how ships with captains still end up on the rocks
33

34. HOW ARE
INVESTORS
REACTING TO
THESE CHANGES?

35. HOW ARE INVESTORS REACTING TO THESE CHANGES?
■ Increased indexation investing:
− Investors are using indexation investing as a core portfolio within a Core-Satellite approach
− This should be true even if investors only use Balanced Funds
■ Increased Smart Beta investing:
− Investors want out-performance, but also want value for money
■ Greater demands being placed on asset managers:
− Display a clear competitive advantage
− Be unique & provide diversification
− Customised Solutions
− Risk Management
■ Increased use of alternatives (to provide unique sources of return)
35

36. WHAT SHOULD YOU
DO?

37. “SELF REFLECTION IS REQUIRED BY THE INDUSTRY”
■ This is true for investors, asset managers & consultants
Source: https://www.youtube.com/watch?v=dSWVXNtI0SU |Kim Parkhurst37

38. WHAT SHOULD YOU DO?
■ Recognise that, even though behavioural biases support the status quo, the changes are
happening fast
■ Ensure that you are fully equipped to understand the implications of these changes:
 We have done numerous educational sessions on:
− indexation investing;
− smart beta investing;
− risk management; &
− alternatives;
 We also create customised solutions across the investment spectrum for large clients
38

39. 39
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