The debate between active and passive

The first exchange-traded index fund saw the light of day in 1993 with the launch of State Street Global Advisors' SPDR - pronounced "Spider" - S&P 500 Trust ETF. That tracker mimics the performance of the U.S. S&P500 index, which includes the largest 500 U.S. companies. It is still the largest and therefore most popular exchange-traded fund (ETF) worldwide. Since 2018, Belgian investors can no longer buy the world's oldest ETF. "It is very unfortunate for investors, but European regulations prohibit brokers from selling products for which they cannot present a European Key Information Document (KID)," said Hans Heytens, head of research and management at Merit Capital. As a result, Belgian brokers have had to withdraw thousands of ETFs for which such a document is not available. These are mostly U.S.-made ETFs. "These are often the most liquid trackers," Hans Heytens knows. "With the lowest costs. Now investors sometimes have to revert to slightly more expensive European trackers. Sometimes there is also simply no European variant with a KID and access to certain assets is cut off. I suspect that the lobby of the banks - who like to sell their own house funds - helped to ensure that these regulations came about."

Capitalize versus distribute

Jan Longeval, independent financial advisor, does not think U.S. equity ETFs are interesting for Belgian retail investors anyway. "U.S. equity ETFs are required by law to pay dividends. A Belgian investor pays tax twice on those dividends: 15 percent in the U.S. and another 30 percent in Belgium. In other words, you lose 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 equity tracker." When trackers or mutual funds reinvest the dividends, it's called capitalizing in the jargon. When they pay out the dividends, we talk about distributing. Hans Heytens: "I would fill half of my equity portfolio with trackers and the other half with actively managed funds. There are certain investments that you can do perfectly 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 as well. Take the example of the S&P500 and other indices that select stocks based in part on their market capitalization. With those indices, you're not buying the entire U.S. market, but a basket of 500 stocks whose composition changes from time to time. The losers fly out and the winners remain. That's kind of a momentum strategy and that's why it's hard to beat the index." For bonds, much the same applies. "Feel free to buy an Ishares Euro Aggregate Bond Ucits ETF if you want to invest in quality European paper. But convertible bonds, bonds from emerging markets or from companies with low credit ratings I would leave to an active asset manager. In doing so, choose a mutual fund with a low cost structure. That's where it starts." He also points out that the actively managed funds of Vanguard, one of the pioneers in passive investing, knock its own low-cost trackers.

Scientific research

For specific investment styles or strategies, Hans Heytens would not turn to ETFs. "Some active asset managers are just better at that." Smart beta or factor investing, however, has become very popular in recent years. That to looking for factors that cause some stocks to outperform the rest of the market. Momentum is one such factor. Value stocks outperforming growth stocks and smallcaps or small stocks beating largecaps or large stocks are another such factor. Jan Longeval, in his book God Doesn't Dice in the Stock Market, shows himself to be a proponent of factor investing with ETFs. He considers it a way for investors to buy active management at a cost much lower than that of actively managed mutual funds. Hans Heytens admits he used to hold that view, too. "But I have come to realize that the creators of indexes all use different definitions for factors that are often not robust. A good example is the definition of quality. Quality comes out on top over time." According to Hans Heytens, dividend growth, low debt or little fluctuation in earnings do not guarantee quality, even though these are often criteria index builders rely on for stock selection. "High and robust profit margins, little difference between cash flow and gross profit, indicating little accounting trickery, and slow and internal balance sheet growth are factors that work," he says.

Differing definitions

Jan Longeval is less harsh on index creators. He argues that a maker of indices such as MSCI does rely on the academic literature to establish criteria for the quality factor. "Those criteria do not guarantee outperformance, but they are objective criteria. It's just that there is no single academic definition of quality, whereas there is for the factor of value: price/book value." The adviser 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 knock the so-called smart beta ETFs with their active funds. "If you want to do value investing, choose Value Square's funds, for example. These are people who invest with a very long-term horizon and from a deep conviction that you should buy undervalued quality stocks."

Source

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