Need to know
- Active and passive management are two different approaches to investment
- A new benchmark, which begins in July 2021, will likely see super funds using more passive investment management.
- Analysis shows that few active managers can 'beat the market' or achieve better long-term returns than passive management.
Passive management is a style of investing that aims to replicate a specific index, such as a stock market. It's a way of investing in the market as a whole rather than trying to pick which individual companies will outperform their peers.
Active management is more about using skill or knowledge of the market to select individual stocks to buy and sell. It's a more hands-on approach that tries to identify which stocks are undervalued (to buy) and which are overvalued (to sell).
The federal government is considering implementing a new benchmark test for super funds that will measure their product to a 'passive benchmark'. Read on for how this might affect your superannuation.
Active vs passive management
An example of how passive management might work in practice is when a passive manager investing in Australian shares may seek to replicate the performance of the ASX 200 (the 200 biggest Australian companies by market cap) by investing in a representative set of companies that make up the ASX. One way to do this is to invest in an exchange traded fund (ETF) that allows you to invest in a basket of all the ASX 200 companies in one transaction.
In contrast, an active manager would research individual companies and market conditions to try to predict the stocks that do better than the market as a whole.
Passive management generally costs less
A crucial point is that passive management generally costs less. Fees are easily overlooked, but are important – there's no point achieving eye-catching returns if higher fees cancel out these extra earnings.
Super funds don't need to pick one approach or the other. They can invest heavily in indexes while also choosing some individual investments.
New benchmark test for super funds
Parliament is considering a suite of changes, called Your Future, Your Super, scheduled to come into force in 2021.
A key reform is a new benchmark test for super funds. This will see the regulator (APRA) compare a superannuation product to a 'passive benchmark' across the past eight years.
This will be based on what the individual product is invested in, so a product invested in 70% shares and 30% cash would have its performance compared with those two markets in the same proportions.
If a product underperforms the APRA benchmark by 0.5 percentage points each year over an eight-year stretch, it will be considered an underperformer. Super funds will have to let their members know if they're in an underperformer and refer them to a new fund comparison tool.
Changes may see more super invested passively
So, how will this affect how super funds manage your retirement savings? You may have seen reports warning that funds may increasingly turn to passive management (or 'index-hugging') because of this new test.
If the regulator is judging funds against an index, the logic goes, more funds will simply invest in a way that replicates that index.
Most active managers can't beat the market or achieve better returns over the long-term than you'd get from a passive investment
But will this be a bad thing? There's now a lot of evidence that most active managers can't beat the market or achieve better returns over the long-term than you'd get from a passive investment.
With this in mind, it becomes clear that for many super funds a move towards more passive management would actually see members retire with more in their savings.
Active management underperforms worldwide
SPIVA (S&P Indices vs Active) scorecards have been tracking the performance of more than 10,000 funds worldwide for more than 15 years.
Its most recent statistics and reports found that 81.7% of Australian equity general funds underperformed the S&P/ASX 200 over five years.
This trend is remarkably consistent across countries. In the US, Canada, Mexico, Brazil, Chile, South Africa, India and Japan, the majority of large-cap equity funds underperformed the market over five years.
Similarly, a Europe-wide survey of equity funds found the majority underperformed the relevant benchmark indices over this timeframe.
There were no regions where the equity funds outperformed the market over five years
There were no regions where the equity funds outperformed the market over five years.
In some regions, a majority of equity funds outperformed the market in the highly unusual calendar year of 2020, but this was an anomaly.
Further research from SPIVA found that only a minority of those who beat the market in a given year can keep this up over several years.
There's one clear conclusion we can draw from this – that outperforming the market in the long-term is very, very difficult.
Vanguard research supports case for passive investing
Investment manager Vanguard (which plans to enter the Australian super market) has published research that found that three in four super funds would've performed better had they simply invested to replicate the relevant indexes.
Over a 10-year period, the super funds had underperformed by an average of -0.8% each year (after fees and tax) compared with the average passive benchmarks.
To put it another way, most super funds haven't been beating the relevant passive benchmarks over the long-term anyway – so it's hard to argue that these funds investing passively will hurt your nest egg.
Vanguard's research also confirmed that more expensive isn't better for super funds, as higher investment costs actually led to lower returns and less in your retirement savings.
Will good funds also turn to passive management?
As we've seen, only a small minority of fund managers can consistently beat the market.
It follows that super funds moving towards low-cost passive investments isn't a cause for alarm – it may even mean you have more in your retirement savings.
Passive management could mean higher savings
Active management is more ambitious than passive management by its nature. But this doesn't mean that people who've invested actively end up with more in their savings. In fact, the evidence suggests it's the opposite in most cases.
Some commentators have claimed the new test will lead to mediocrity as more funds invest to replicate the index.
But once the new test is in place, there will still be a powerful incentive for funds to try to beat the benchmark rather than just match it. If a fund can show it's outperformed its peers, more people will be likely to join.
YourSuper comparison tool
Another important change coming in July 2021 is the YourSuper comparison tool. This will let people easily compare and switch super funds.
"Funds who've been underperforming the market will likely see an improvement by adopting a low-cost, passive approach once the benchmarks are in place," says Xavier O'Halloran, director of Super Consumers Australia.
[YourSuper] will make it easier than ever for Australians to compare funds and see which ones are managing their retirement savings bestXavier O'Halloran, director of Super Consumers Australia
"There'll still be a carrot for any funds that manage to beat the market over the long term, as people will look to them to take care of their retirement savings.
"In fact, the new comparator tool will make it easier than ever for Australians to compare funds and see which ones are managing their retirement savings best."
This content was produced by Super Consumers Australia which is an independent, nonprofit consumer organisation partnering with CHOICE to advance and protect the interests of people in the Australian superannuation system.
Stock images: Getty, unless otherwise stated.