Index investing can be just as risky as active management, head of UK-based firm Create Research, Amin Rajan, told Australasian investors last week.
Rajan, who publishes a highly-regarded annual global investor survey in association with Principal Global Investors, said passive investing might be cheap “but it’s not always cheerful”.
“If you’re a serious long-term investor [passive investing] is not necessarily the best way to secure your future,” he said. “The trend to passive investing comes at a price – cheap is not the same thing as value for money.”
According to Rajan, statistics that appear to write off the value of active management tend to overstate the case.
“About 35 per cent of active managers are performing,” he said. “It’s the closet-indexers giving the rest of active managers a bad name.”
Rajan said passive investing offers investors a particularly unrewarding way to access emerging markets.
He said broad emerging market indices are inefficient with big differences between countries lumped under the same asset class.
“Emerging market indices are completely meaningless,” Rajan said. “The dispersion between the best and worst [of emerging market countries] is massive.”
He said emerging markets indices don’t distinguish between more promising markets – such as the Philippines, Mexico, India and Indonesia – and problematic countries like Brazil.
In 2014 Create expanded on that theme in a report titled ‘Not all emerging markets are created equal’.
“In a downturn all emerging markets get tarred with the same brush,” Rajan said. “That opens up buying opportunities for active investors.”
He said while investing in country-specific indices might offer better value than broad emerging market benchmarks, active stock-picking should be more rewarding for long-term investors.
“It pays to be selective.”
The current China-sparked market volatility could “well be the golden age of stockpickers”, he said.
“If active managers are ever going to deliver results, now would be the time.”
Rajan was also skeptical about the ‘smart beta’ trend, where managers attempt to bundle active-like strategies in index-styled vehicles.
“Smart beta is a good idea – delivering alpha returns at index prices,” he said. “But what was supposed to be a low-cost way to access alpha has proven to be not so low-cost as imagined.”
Despite a lot of talk about smart beta, Rajan said investors have been relatively slow to commit money to the strategies.
He said, based on flows to exchange-traded funds (ETFs), smart beta makes up only about 10 per cent of the index-investing business.
Figures from the July 2015 BlackRock Global ETP [exchange-traded products] Landscape report show smart beta funds account for about $255 billion of the almost US$3 trillion in ETPs.
According to the BlackRock report, smart beta ETP flows have been above trend for several years.
“Global smart beta ETPs are experiencing strong flows for a third consecutive year,” the ETP Landscape report says.
“Assets have expanded rapidly, growing at an annualized rate of nearly 40% since the beginning of 2012. This is twice the rate for the broader ETP industry.”
However, Rajan said smart beta returns tend to be generated by the frequency of fund rebalancing rather than choice of underlying risk factors.
“[Frequent rebalancing] comes at a cost,” he said.
Rajan was speaking in Australia last week as a guest of Principal Global Investors.