More than two decades of hard data shows that index-based investment strategies are difficult to beat over the long term – especially after taking fees into account.

A recent webinar hosted by 10X focused on the bi-annual S&P Indices versus Active (SPIVA) reports, which have been compiled by S&P Dow Jones Indices for the past 20 years.

The scorecards provide insights into how well actively managed funds are performing relative to their benchmarks, and where they can generate value for investors. It has not been an easy task.

Over the past 10 years, 93% of active managers underperformed the S&P South Africa 50 Index, and 70% underperformed the S&P South Africa Domestic Shareholder Weighted (DSW) Capped Index.

A similar trend can be seen in international markets.

“The SPIVA scorecard challenges the perception that using low-cost index-based tools as key portfolio building blocks is settling for average,” Tim Edwards, MD & Global Head of Index Investment Strategy at S&P Dow Jones Indices, said on the webinar.

However, the data also shows that some active managers can beat the market over the long term, which means they are certainly worth their fees, Edwards added.

But considering that only a small percentage achieve this feat, they can be difficult to find. They also have a tougher time winning in certain markets, asset classes, and market conditions.

“So what we do with these scorecards is help inform decisions – we give people information on where beating the market is easy, where it’s hard, what times it’s easy, and what patterns of exposures managers might be taking that’s leading them to outperform.”

Edwards said the professionalisation of financial markets in recent decades, and the comparatively high costs associated with active management, partly explained the underperformance of most active managers.

Yet while active managers struggle to beat both domestic and global equities indices, they tend to fare better in fixed income markets, in global small-caps, and in some years.

For instance, only 23% underperformed relative to South Africa’s short-term bond index – as they take on extra risk in this space – and 51% underperformed the aggregate bond index. But after subtracting fees, it becomes difficult to add value in these segments.

Despite how tough it is to beat the market, South Africa lags developed markets when it comes to the adoption of index-based investment strategies.

Passive funds account for only around 6% of the domestic market, noted Chris Rule, Head of Client Solutions at 10X.

This can be partly explained by the country’s “fragmented beta market” – or the lack of consensus on the most appropriate benchmark to use.

Some indices remain heavily weighted towards a handful of large corporates that essentially outgrew the South African market some time ago, while others adjust individual stock weightings to reflect local ownership, and are therefore more representative of the domestic economy.

This lack of consensus complicates things for decisionmakers, who are hesitant about adopting the wrong benchmark.

Encouragingly, Rule said, South Africa is gravitating towards a “converging beta environment” as legacy dual-listed stocks see reduced weightings in the composite index.

As beta yardsticks become more representative of the domestic market, and new Regulation 28 rules allow for higher offshore allocations – negating the need to track indices that are heavily weighted towards dual-listed shares – index-based strategies should gain further traction.

“And notwithstanding all of the complexity around the South African beta landscape, an allocation to any of the indices has been a good allocation relative to the general equity category over the long term,” Rule said. “This shows the importance of having a meaningful allocation to equity, and one that is low cost.”

In any case, said Rule, “there’s no such thing as a passive investment”, since the decision to invest in a low-cost passive product is inherently an active one.

Learn more about our flagship South African equity investment, the 10X Top 50 here.

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