To quote Barry Schwartz from his book The Paradox of Choice: Why More Is Less: “On the other hand, the fact that some choice is good doesn’t necessarily mean that more choice is better.” Paradoxically, as financial markets and investment products evolve, it has never been easier to invest; yet, more complicated to decide on an investment. This ‘Paradox of Choice’ scenario means there are too many investment options, which could result in uncertainty or hesitancy in making an investment decision. This sometimes leads to investors not investing at all, or being dissatisfied with their investment decisions.
However, research has also shown that the more informed or experienced an individual is, the more confident they are in making a decision, and prefer having more options. Experienced investors are more likely to make investment decisions and tend to have less dissatisfaction with any decisions made. Part of this is also attributable to the fact that experienced investors might be looking to invest in very specific sectors, themes or factors, considering their own experience and forward-looking market expectations.
As with many things in life, we often need to consider the past and the present before making an investment decision.
A brief history of active versus passive investment management
Unit trusts, or mutual funds internationally, have been a popular investment choice in South Africa for decades. Managed by professional portfolio managers, they invest in various assets on behalf of investors within an investment mandate. Given market volatility, managers often actively decide which assets to buy, hold or sell – known as ‘active’ portfolio management.
In 1976, John C Bogle of Vanguard created one of the first index mutual funds. Index funds track specific indices, a strategy called ‘passive’ portfolio management. Since then, debates over active vs. passive investing have sparked worldwide.
The first Exchange Traded Fund (ETF) was listed in the 1990s, initially as passively managed funds tracking indices. In 2008, the first Actively Managed ETF (AMETF) was introduced. South African ETFs have been on the Johannesburg Stock Exchange (JSE) for over two decades, but the first AMETF was only listed in 2023.
While active management pioneered unit trusts, passive investing led to ETFs. Now, with AMETFs on the JSE and passive unit trusts available, investors can access diverse strategies across both. AMETFs offer intra-day trading and liquidity while maintaining active management benefits. Investors can trade ETFs directly via stockbrokers without needing an investment platform.
The way forward on active versus passive investing
As actively managed funds grew, experienced investors welcomed the increased competitiveness and choice among active managers. This allowed them to select funds or managers with different styles, strategies and philosophies, while considering investment cycles, macroeconomic views and market expectations. They understand that historical performance doesn’t always indicate future performance and that investment decisions are forward-looking.
Initially, passive portfolios simplified investment decisions. Instead of selecting an active manager and risking underperformance, passive portfolios typically deliver returns aligned with their benchmark, often similar to actively managed funds. While investors seek higher returns, it’s arguably easier to accept benchmark-related returns than relative underperformance.
A new world of possibility with ETFs
With the introduction of ETFs, experienced investors quickly understood the benefits and intra-day trading and liquidity with reference to an underlying benchmark. ETFs tracking traditional market capitalisation indices continue to be popular due to their diversification, lower costs, liquidity, familiarity and transparency. ETF issuers also started offering products referencing various other indices, with varying exposures within a specific market or to a specific sector, and various other fundamental and mathematical factors such as momentum, value, growth, capping or equal weighting, for example, with some indices including multiple factors plugged into the index calculation methodology.
As experienced investors, it is not uncommon for active managers to invest directly or indirectly into traditional or specialised indexation products and strategies for various reasons, as part of their overall strategy – as greater choice also offers increased opportunities.
However, just because some investors might have more experience, it doesn’t necessarily mean they always make better investment decisions, especially after taking into consideration the various costs associated with making an investment decision. Often, on a relative basis, simple cost-efficient investments into established traditional market benchmarks or indexation exposures can deliver better returns over the long term, although not necessarily the best. However, with ever-increasing investment options and alternatives, selecting the best is an increasingly daunting task. This is further complicated when one considers historical performance as a comparative measure, even though future performance is uncertain, and investments are also forward-looking.
Remain biased towards action to stay in the game
As with all decisions, investors need to determine their own investment objectives, requirements and expectations. This typically requires research and potentially seeking advice from an investment professional, as part of gaining investment knowledge and experience. It is, however, important to remember that ultimately the main decision is to invest.
To quote Barry Schwartz again: “Learning to accept ‘good enough’ will simplify decision-making and increase satisfaction.” So, instead of being overwhelmed by the ‘over-choice’ or ‘analysis paralysis’ of making an investment decision, sometimes a simple decision that makes sense to you can be good enough and just as rewarding. After all, experience needs to start somewhere.
This article is not ‘advice’ as defined and/or contemplated in terms of the FAIS Act.
