Passive investments are not designed to outperform the indices they track, but they provide exposure at a very low cost. Active funds, on the other hand, are the vehicles for fund investors to seek long-term market out-performance, however, only a minority of fund managers are able to deliver it, FSA reported earlier. The mutual fund industry therefore seeks to combine the two approaches.
“Institutional investors have been experimenting with different ways of doing this,” Johnnie Yung, head of portfolio strategists for Asia ex-Japan at State Street Global Advisors, said during a panel discussion at an S&P Dow Jones Indices seminar. “Some of them build the core portfolio with passive funds and add active products in order to generate alpha. Institutions can also complement their active portfolios with passive products to fill gaps caused by a lack of investment talents in certain areas. Others use passive strategies to hedge risk.”
Risk management
Comparing ETFs to derivatives as a risk hedging tool, Yung said that exchange-traded products in general have a cost advantage and are more tax-efficient. “When using derivatives such as futures, there are several costs for the managers. However, ETFs carry low expense charges and have simple fee structures,” he added.
Additionally, the regulatory burden involved in holding ETFs is also lower compared to derivatives, he added. “ETFs are simple products that offer exposure to some specific geographic location or sector. The mechanism is not complicated as investors will only have to buy and hold,” he said.
Nathan Zahm, senior investment strategist at Vanguard, noted that there are several areas where active and passive products are complementary.
Passive investing in a high-turnover asset class or where holdings are highly concentrated may not be ideal, he said. “For instance, the high yield space is a less liquid environment. There are a lot of concerns whether the benchmark can be replicated fully, in particular in markets under stress,” he said.
He also added that many straightforward, market cap-weighted strategies take similar exposures to large-cap indices. He believes that the emergence of smart-beta products and actively-managed ETFs will add diversity to the market in the region.
Blended approach
Julian Liu, president and CEO at Yuanta Securities Investment Trust, said that he has tried to bring people from active and passive products together to learn about different approaches.
“ETF specialists have undergone training on the bottom-up analysis while the active investment team has to learn how to trade passive funds,” he said. The firm is yet to see any significant results of this, but Liu expects that hybrid products can generate new and more effective investment ideas.
