Passive funds have become a popular investment choice in South Africa. They are widely regarded as being suitable for retirement savings, offering a simple structure and the opportunity for sensible diversification.
Also known as tracker or index funds, passive funds target a return in line with a particular market or index, explains Luigi Marinus, Portfolio Manager at PPS Investments.
The Regulation 28 compliant PPS Balanced Index Tracker Fund was designed as a passive, passive multi-asset high equity option for long-term investors. The fund uses passive building blocks to obtain the desired asset allocation. This means that each underlying asset class tracks an index, e.g. the domestic nominal bond exposure tracks the JSE/BEASSA All Bond Index (ALBI) and the domestic property exposure tracks the FTSE/JSE Property Index (SAPY).
The second level of the passive approach applies to the fixed asset allocation. This means that the allocation to each asset class is decided at the outset and cannot be adjusted even as perceived market conditions change. The fund is rebalanced to align to the original allocation as well as remain Regulation 28 compliant.
“Circumstances recently necessitated an unscheduled change to the asset allocation of the fund – the first such change since the fund was launched three years ago. This change was intended to accommodate changes to the maximum offshore allowance under Regulation 28, as well as mitigate against a skewed allocation within the underlying domestic equity index,” says Marinus.
In the best interest of investors and with their consent via a balloting process, PPS Investments decided that the prudent choice would be to make a once-off change to the asset allocation.
Increase the offshore asset allocation
When the PPS Balanced Index Tracker Fund launched, its 17.5% strategic asset allocation to offshore equities was well within the maximum allowable offshore exposure of 25% for the sector. It was meant to represent an appropriate allocation throughout the economic cycle and aligned to the peer group average over time.
However, earlier this year, the maximum offshore allowance was increased to 30%.
“Following this, we envisaged that the peer group allocation would also increase. This led to the decision to increase the fund’s offshore allocation to 22.5%, which is still within the maximum allowance and more in line with the expected average peer group allocation over time,” says Marinus.
The additional global equity allocation provided the opportunity to introduce global emerging market equities at an exposure of 4% of the fund.
Furthermore, in order to accommodate the 5% increase in the offshore allocation, the domestic equity allocation and the domestic cash exposure were each reduced by 2.5%.
Switching the underlying index to reduce too much single-stock exposure
The second adjustment was switching the underlying domestic equity index from the FTSE/JSE SWIX Index to the FTSE/JSE Capped SWIX Index. Initially, the FTSE/JSE SWIX Index was the industry accepted domestic equity benchmark. However, the Naspers share price has become a disproportionately large holding within the index.
At its peak, Naspers made up roughly 25% of the SWIX Index. “The risk associated with such a large exposure to a single stock was greater than what the fund was ever expected to assume,” says Marinus. The domestic equity peer group had a similar perspective and the accepted industry benchmark changed to the FTSE/JSE Capped SWIX Index. This index caps any single stock exposure to 10%, which then limits the risk that could be associated with a large exposure to any single stock.
The table below shows the changes to the strategic asset allocation of the fund.
“The PPS Balanced Index Tracker Fund is still able to deliver on the objectives as set out when the fund was launched. It was designed to maintain a diversified asset allocation with a high allocation to equities and reasonable exposures to other asset classes at all times,” says Marinus.
He adds that these allocations should not be subject to changes as perceived value changes.
Furthermore, this should deliver a competitive peer relative performance without assuming undue risk.
The recent enhancements reinforce the fund’s objectives as the total equity exposure increased from 65% to 67.5%. Furthermore, diversification improved by adding exposure to emerging markets and by changing the domestic equity exposure to the Capped SWIX Index to reduce the risk of large exposure to any single stock.
“Furthermore, since inception, the fund has outperformed the peer group average by nearly 1% per annum despite the relatively lower offshore exposure to the average fund in the sector and over a period where the rand depreciated by more than 6% against the dollar,” Marinus says.