The debate between active and passive

The first listed index fund was launched in 1993 with the launch of State Street Global Advisors' SPDR — pronounced “Spider” — S&P 500 Trust ETF. This tracker mimics the performance of the US S&P500 index, which includes the largest 500 US companies. It is still the largest and thus most popular exchange-traded fund (ETF) worldwide. Since 2018, Belgian investors have been unable to buy the world's oldest ETF. “It's a shame for investors, but European regulations prohibit brokers from selling products for which they can't submit a European Key Information Document (KID),” said Hans Heytens, head of research and manager at Merit Capital. As a result, the Belgian brokers had to remove thousands of ETFs for which such a document is not available. This mainly concerns American-made ETFs. “These are often the most liquid trackers,” says Hans Heytens. “With the lowest costs. Now, investors sometimes have to go back to slightly more expensive European trackers. Sometimes there is simply no European variant with a KID and access to certain assets is cut off. I suspect that the lobby of the banks — which like to sell their own house funds — helped to ensure that these regulations were put in place.”

Capitalize versus distribute

Jan Longeval, independent financial advisor, does not find US equity ETFs interesting for Belgian private investors anyway. “U.S. stock trackers are legally required to pay dividends. A Belgian investor pays tax on those dividends twice: 15 percent in the US and another 30 percent in Belgium. In other words, you've lost half of your dividend yield. European trackers may be more expensive, but not that much. Small Belgian investors are always better off with a capitalizing European stock tracker.” In the jargon, when trackers or investment funds reinvest dividends, that's called capitalizing. When they pay dividends, we talk about distributing. Hans Heytens: “I would fill half of my stock portfolio with trackers and the other half with actively managed funds. There are certain investments that are perfect for you with trackers. I'm thinking of ETFs that track indices with large, liquid stocks or bonds, which allow you to give certain regions or sectors a certain weight in your portfolio.

Simple index investing is often already a form of active investing. Take the example of the S&P500 and other indices that select stocks based on their market capitalization, among other things. With these indices, you are not buying the entire US market, but a basket of 500 stocks whose composition changes occasionally. The losers fly out and the winners remain. That's a kind of momentum strategy and that's why it's hard to beat the index.” About the same applies to bonds. “Feel free to buy an Ishares Euro Aggregate Bond Ucits ETF if you want to invest in European quality paper. But I would leave convertible bonds, bonds from emerging markets or low-credit companies to an active asset manager. In doing so, opt for an investment fund with a low cost structure. That's where it starts.” He also points out that Vanguard's actively managed funds, one of the pioneers in passive investing, are true to its own low-cost trackers.

Scientific research

For specific investment styles or strategies, Hans Heytens would not use ETFs. “Some active asset managers are simply better at that.” However, smart beta or factor investing has become very popular in recent years. This is about looking for factors that ensure that some stocks perform better than the rest of the market. Momentum is one such factor. Value stocks that perform better than growth stocks and small caps or small stocks that are worth large caps or large stocks are another factor. In his book God dice not on the stock market, Jan Longeval is a supporter of factor investing with ETFs. He thinks it's a way for investors to buy active management at a cost much lower than that of actively managed investment funds. Hans Heytens admits that he also used to be of that opinion. “But I've come to the conclusion that index creators all use different definitions for factors that are often not robust. A good example is the definition of quality. In the long run, quality will come to the fore.” According to Hans Heytens, dividend growth, low levels of debt or low fluctuations in profits do not guarantee quality, even though these are often criteria that index builders rely on for stock selection. “High and robust profit margins, little difference between cash flow and gross profit, which suggests few accounting tricks were used, and slow and internal growth in the balance sheet are factors that work,” he says.

Divergent definitions

Jan Longeval is less strict with index makers. He states that an index maker such as MSCI does indeed use the academic literature to determine the criteria for the quality factor. “These criteria do not guarantee additional performance, but they are objective criteria. However, there is no single academic definition of quality, while that definition is there for the value factor: price/book value.” The advisor also adds that very different definitions of quality are also used in the world of active fund managers. According to Hans Heytens, Robeco and Dimensional Fund Advisors are two fund houses that use better definitions and can beat the so-called smart Beta ETFs with their active funds. “If you want to invest in value, choose Value Square funds, for example. These are people who invest with a very long-term horizon and a deep conviction that you should buy undervalued quality stocks.”

Source

• Source: Trends
• Author: Ilse De Witte
• Date: 12/12/2019
• www.trends.be