Corporate South Africa has long prided itself on its the highest global standards of accounting, transparency, ethics and accountability. A strong corporate culture and deep and liquid financial markets for years has set South Africa apart from many of its emerging market peers. Over the last three years though, this has all started to unravel like a Proteas middle order against a quality bowling attack.
The local market has been plagued by corporate scandals for so long now that investors must feel like they are playing hop scotch through a minefield. It seems to have become a regular occurrence, Tongaat being the latest transgressor, as SA’s largest sugar producer is in crises as a result of accounting irregularities, resulting in the company’s equity being overstated by approximately R3.5 to R4.5 billion. Trading in the 127-year old company shares has been suspended on the JSE and London exchanges.
Not to mention a certain IT company that used to be a darling of our market for almost two decades, but the raging share price made a dramatic reversal when Microsoft terminated a contract with one of its subsidiaries and launched a probe into the group’s public sector contracts. EOH’s destruction of shareholder value due to dubious business practices and a blatant lack of corporate governance can be bested only by Steinhoff in recent times. EOH also had three pivotal board members resign last week in case you are struggling to keep up – who could blame anyone for that.
This is becoming all too familiar for investors on the JSE, Steinhoff being the most widely recognised corporate scandal in our history, but it seems as though this was the initial fuel that led to a fire of individual listed companies destroying shareholder value. The problem with the system is it seems as though the shareholders are the ones who have to pay, not those responsible. Companies like Steinhoff, MTN, EOH, the Resilient Group (to some extent) and Tiger Brands all come to mind.
There are few active managers that would have avoided all/some these stocks over the last couple years. The question is whether they had over/underweight positions relative to the ALSI, this would have had a big influence on whether they were able to outperform the general market or not. We wouldn’t place our heads on a block and say that no one got this right, but on average, it would be reasonable to assume that most of them didn’t. It is also reasonable to assume that the management fees clients are paying these institutions did not change, even if they did get it wrong.
To outperform inflation over the long term, one has to take risk in equity markets to chase yields above what the money/bond market can give you. Responsible investment practices will tell you that when you have time on your side (being 5 years plus at least) equities is the place to be. The problem is that with these so-called mines that need to be avoided, how can an investor reasonably expect to achieve this?
Passive solutions will probably guarantee that you had exposure in these stocks and the losses would not have been avoided, but this would have happened at a much smaller scale. An ETF portfolio would have limited your losses to much less than if your wealth was tied up in an active manager who got it wrong. Active managers can take overweight positions of up to 15-20% on a single stock, where underweight positions generally have about 2.5-3% exposure (based on their level of conviction).
A portfolio of ETFs would have probably caused investors to be underweight the bombs in our market and limited this exposure to no more than 1.5%. Passive solutions are generally also a cheaper way of investing as opposed to active managers or a combination of unit trusts.
Therefore, it is a reasonable assumption to make that a passive strategy would have outperformed the majority of active managers over the last 5 years. It probably wont always be this way as the relationship between these two investment methods seems to be as cyclical as the markets themselves. There is no doubt that active managers will have their day again, but for this to happen, a stronger culture of corporate governance is essential and needs to change first.
One thing is certain in the current climate, for the layman who generally just wants to outperform inflation with the equity portion of his/her asset allocation, passive solutions will most definitely allow them to sleep a lot better at night.