Issue: September/November 2008

Index funds may be cheaper, but are they appropriate for the risk-averse? Not necessarily, believes Metropolitan Asset Managers managing director Robert Walton.

Robert Walton

Walton . . . active attractions

A recent study of index funds versus actively managed funds suggested that index funds might be a slightly better option for investors, thanks largely to lower fees. But active fund managers still have a major role to play, particularly for an array of investors who simply don’t want the volatility associated equities or index funds.

Index funds – funds which track a particular index such as the Alsi 40 – are gaining popularity as a cheap way to access the equities market (illustrated by products like Satrix). Yet this type of investment might not be appropriate for all types of investors, particularly those with less appetite for risk and especially since the Satrix 40 index exposure to resources stocks is very high.

Generally, index funds are great if a portion of individuals’ investments are invested in these products as part of a balanced portfolio. Full exposure to index funds can, however, leave investors at the mercy of market volatility, which can turn south at any time for any number of reasons as recently demonstrated by the US sub-prime crisis, the 9/11 attacks, or the Russian debt crisis before that.

SA’s most popular index funds are equities-based. However, there’s a plethora of investment options available, both equity and non-equity based, that still provide investors with some degree of protection.

Guaranteed funds

Using Metropolitan Asset Managers’ performance figures as a proxy illustrates that, while it would be difficult to compare any investment to the local equities boom (which has been extraordinary by any standard, yielding more than 30% p.a. for five years), guaranteed products have also achieved outstanding returns. This is good news for investors who are worried about when the market will correct.

Absolute Return Funds (ARFs) are managed with the aim of achieving an absolute return relative to a benchmark like cpi+5%. ARFs are not managed around specific equity, bond or cash allocations as portfolio managers use alternative strategies (such as derivative instruments) to manage risk around current economic factors more effectively than relative fund managers. Investors therefore know that they are investing in a vehicle where risk is being managed.

The Metropolitan Absolute Return Fund is a Regulation 28-balanced fund. It includes a proportionate mix of cash, bonds and equities. The aim is to manage the downside risk by providing a measure of protection, thereby preserving capital while meeting the performance target of cpix plus 5%. Unlike the traditional balanced fund, the advantage of the Metropolitan ARF is that it provides a source of additional returns when the equity index moves sideways or declines.

Also popular are guaranteed Smooth Bonus Funds that “smooth” out returns over the long-term and strive to provide investors with a stable income stream even if markets dip. A comparison between inflation (measured by cpi) and the investment bonuses for retirement

annuity policies invested in Metropolitan Life’s Smooth Bonus Portfolio outperformed inflation by 15,15%, 15,45%, 7,45% and 6,74% per year respectively for three, five, 10 and 15-year time horizons. In each case, bonuses outstripped inflation by at least two to one.

Other funds to consider

While the bond market has been battered by sustained worse-than-expected inflation numbers, analysts are upbeat that SA is nearing its inflation peak. And once the numbers start dropping we can expect the bond market to rally as yields fall, which will be good news for bond-based funds. Investors should keep a close eye on inflation developments.