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Passive investing set to be tested hard

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.”

To see Mark Riggall’s video interview on the benefits of smart active investing please click here.

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