South African asset managers lag developed world leaders in terms of the movement out of actively managed funds and into index funds, and South Africa is definitely “first world when it comes to our financial services industry”, says Van Heerden.
“The numbers are scarily low,” he says. “In the unit trusts space, for example, just 6% of funds in SA are passive. Compare that to the UK, where around 18% of funds are passive. In the institutional space, our numbers are even lower than that, compared to 30% in the UK.” Passive funds have also grown rapidly in the US, with more than 40% of the market being in passive funds, but many will see the UK as a better comparison, due to so-called tax-harvesting in the US.
Slow uptake in South Africa comes despite established evidence, both locally and abroad, that passive funds have a compelling investment case in any portfolio.
“There can be no doubt that passive funds should form part of an investment strategy in most instances,” says Van Heerden, who joined 10X from Ninety One (formerly Investec Asset Management), where he ran the Middle East and Asia office after a long stint as head of the company’s institutional business in South Africa.
He believes the main reason for the “disconnect” between the growth of indexing in South Africa and the rest of the world is that the prices of passive investments in South Africa are still too high.
“Over the last 20 years the average total expense ratio on mutual funds, both active and passive, has moved from 0.93% to 0.41%,” Van Heerden said, referencing global numbers from Morningstar. “The average fund fee is 0.62% for active and 0.12% for passive. In South Africa, active funds sit at around 0.75%, while the passive price is around 0.40%.”
He sees two main reasons for South African passive asset management being “totally out of whack” with the global industry: convoluted business models and a sub-optimal pricing mechanism.
“Business models for passive players in South Africa are convoluted and, therefore, fees are not what they should be. The difference between what you are paying for active and passive is not big enough for investors,” said Van Heerden.
“Why should I pay 0.65% for a passive China fund when I can pay 1% or less for active, in a universe that is alpha rich. If we can provide China exposure at 0.20% to 0.25%, it becomes a different discussion.”
“If you look at the two biggest players in South Africa, one is tied to a life insurer and has to carry high overhead costs, while the other is essentially a multi-manager.
“At the moment, there’s no clear, independent pure-play passive house that’s large enough to really compete in the market,” he says, adding that it’s unlikely that big, traditional players will lead the way in bringing passive fees down.
“If you’re sitting in a house where you have large overheads that you must pay to your mothership, it’s very hard to bring fees down.”
Ultimately, the change will come only when passive funds fundamentally change the way they operate. “A truly independent house has to weed inefficiencies out, has to build scale, and has to have the meritocracies in place that allow it to push fees down. The passive game is winner takes all.”
The other big part of the problem is the way fees are calculated. Currently, says Van Heerden, it seems fund managers look at their competitors to work out what is the highest price customers are willing to pay. Downward pressure comes when competitors come in lower.
Van Heerden argues that the starting point should be: What does it cost to manufacture these products, and what is a reasonable profit margin?
“If the fee that you arrive at is way above the market, then it is something you are not efficient in and there is work to be done.”
He adds that what has driven the global leaders is efficiency and scale: “The biggest players take the lion’s share of inflows because they have scale and can price down aggressively.”
“10X have been early adopters of technology, which provides an excellent platform to disrupt the current savings and wealth management regime in South Africa. The big gambit for us is to build a robust business model that can develop scale and eke out efficiencies so that we can start charging in line with our global peers,” Van Heerden said.
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