Wednesday, 30 November 2016

Passive vs Active Investing

The issues investors need to get to grips with when looking at index trackers. Any conversation about investing will eventually come round to the active versus passive debate: is it better to pay more for a manager who will take ‘bets’ in the hope of beating the market or to just accept market-like returns and make a big saving on management fees?

There’s no definitive answer to this of course, but the second approach – which is known as index tracking or passive investing – has a strong following in the US and is growing in popularity at an ever increasing rate in the UK and Europe.

Index investing revolves around the view that it is difficult to outperform the market over the long term so attempting to match its performance by tracking it as closely as possible is the best approach. These products have a very simple objective: follow an index’s performance but don’t add to effort or cost in trying to beat it.

There are advantages to passive investing. Tracking an index means that risk is spread across the market, thus reducing the chance of an investor finding themselves overly exposed to one area just because it is the favoured hunting ground of an active investor. History tells us that active managers are by no means guaranteed to get their calls right. This approach also cuts down on research and trading costs, meaning trackers tend to have an automatic head start ahead of their more expensive rivals.

However, there are risks too. Investors in tracking are fully exposed to broad market declines, whereas savvy active fund managers can protect their investors by holding parts of the market they expect to hold up well. They can even up their exposure to cash if they feel particularly threatened.

Moreover, as with any fund, there’s always the risk of picking the wrong product. While in a perfect world all passive funds would be equal, there’s a number of key issues that differentiate them and can make some perform much better than others. Just because you buy an index tracker does not necessarily mean you get index returns. Indeed, sometimes the difference in performance can be significant.

Passive investors typically make use of two kinds of fund: traditional indexed funds (often referred to as trackers) or exchange-traded funds (ETFs).

Trackers are essentially the standard unit trust or open-ended investment company (OEIC) that most investors are familiar with, but they are not actively managed and simply seek to replicate an index. They are bought directly from a fund management company or through a platform.

The aim of an ETF is the same. The key difference is that these products are traded on stock exchanges, meaning unlike unit trusts and OEICs they are priced continually through the day and investors can buy or selling whenever the exchange is open, rather than at limited times. Given that the issue of costs often drives investors to passive funds in the first place, it’s no surprise that this is one of the first things they consider. Costs are of course very important; while some trackers are very cheap, charging less than 0.1 per cent in some cases, others are almost as expensive as active fund managers. However, while a cheap tracker has an automatic head start, this doesn’t mean it will necessarily deliver a better result. Some of the cheapest trackers on the market have been very poor at replicating their index, which in most cases cancels out the cost advantage they had in the first place.

As always seek professional advice from a qualified advier where appropriate.

Friday, 11 November 2016

The “Indian Star” still set to shine

Indian equities are more attractively valued than most other emerging market stocks and could be the star set to shine brightest within the rallying emerging market space due to more attractive valuations and stronger economic fundamentals. The country’s stock market is likely to have further to run despite concerns that the MSCI Emerging Markets index has already performed strongly this year.

India has lagged behind rallying regions such as Brazil and Russia year-to-date, which have been bolstered by the increase in commodity prices and formerly poor returns reducing valuation risk for investors. The rebound in emerging markets has been driven by a rally in value stocks, particularly in markets which had been worst hit. Both Russia and Brazilian markets had suffered from political issues and were impacted by the collapse in commodity and oil prices, India on the other hand has slipped behind as the initial euphoria of prime minister Narendra Modi’s election gave way to disappointment that changes were not likely to immediately impact the economy.

Following five lacklustre years for emerging market equities, the sector rapidly gained popularity this year due to aforementioned commodity prices and heightened political uncertainty across most developed markets. This, combined with historically high valuations across the likes of the US and the UK, led to many investors piling into the market.

Given that the MSCI Emerging Markets index has almost tripled the performance of the FTSE 100 and has outperformed the MSCI World index by more than a third in 2016 so far, investors could well be looking to trim their emerging market exposure rather than adding to it.

However, there are three main drivers at play for the Indian economy specifically, which could therefore have a positive knock-on effect on Indian equities. Firstly, market valuations in the country are far cheaper on average than other emerging market countries and, while valuations are still high, says they are not particularly so for India.

Secondly, the country’s GDP is strong, with the Indian economy growing by 7.3 per cent last year compared to 6.9 per cent in China and 3.1 per cent for the rest of the world. According to the country’s GDP data, this is expected to rise to 7.5 per cent in 2017. India’s current account deficit has fallen from 4.7 per cent of GDP in 2013 to 1 per cent expected this year, whilst overseas debt is now 23 per cent of GDP. As such the country is less sensitive to rising US interest rates or a strong dollar.
The third main driver for India is its favourable demographics, given that 55 per cent of the population are under 30 while 54 per cent are of working age, which he says will continue to rise given the skew to under 30s.

The implementation of a goods and services tax, the increase in the number of Indian citizens with access to a bank account and widespread foreign direct investment are all set to improve corporate governance and boost the economy’s growth. There is still a long way to go before Indian reforms are complete and there are risks when investing in any emerging market. However, the reforms being made today could unlock India’s potential. Much of the reform will help reduce corruption which has plagued the country and bring the informal economy into the mainstream. Modi is also making India a much easier place for companies to conduct business.

The growth potential of India and indeed the growth already coming through is not currently reflected in the market’s valuations which are trading close to their long-term averages and thus provides an interesting investment opportunity. As always seek advice where appropriate.