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Exchange Traded Funds’ explosion forced down investment management fees

Exchange Traded Funds’ explosion forced down investment management fees

By Larry Hatheway, Head of Investment Solutions and Group Chief Economist at GAM.

ZURICH – Investors have long debated whether their portfolios should be actively managed or passively track a market index. But that discussion is becoming a sideshow. Encouragingly, attention is shifting to what matters most: the active decisions about strategic asset allocation that largely determine subsequent investment returns. To paraphrase Milton Friedman in the 1960s, we are all active now.

True, passive global exchange-traded funds (ETFs) have experienced explosive growth – from just over US$200 billion in assets in 2003 to more than US$4.6 trillion last year – which has enabled them to gain market share from more expensive actively managed funds. And investors should always take the lower-cost option if paying higher fees for an active fund brings little additional value (especially during bull markets, when simply being in the game can yield outsize returns). Yet the rapid rise of low-cost ETFs has had two other important effects on investment management.

First, active management fees have come under pressure, particularly for weaker-performing funds. For example, the proportion of hedge-fund managers charging “two and twenty” fees –a 2% management fee plus 20% of any profits earned – has fallen below one-third. Given mediocre hedge-fund performance over the past decade and the emergence of liquid alternatives, it’s surprising that fees haven’t fallen further. Moreover, average fees for active funds across all investment strategies fell from about 1% in 2000 to 0.72% in 2017, a downward trend that shows no signs of abating.

Second, the proliferation of ETFs has blurred the distinction between passive and low-cost investing. Strictly speaking, a passive strategy is one that continuously rebalances a portfolio to track a market-capitalization-weighted index. Yet many ETFs go well beyond this textbook definition by offering investors exposure to particular regions, sectors, factors, or types of credit, as well as a multitude of other “sub-market” criteria. These funds are not passive, but rather instruments for expressing active investment views inexpensively.

But now ETFs themselves face challenges. Several decades ago, the advent of cheaper investment vehicles, including ETFs, boosted investors’ net returns. Between 1979 and 1992, for example, the average weighted retail mutual-fund expense ratio was about 1.5% (including sales load fee). But with the average fee on actively managed funds now below 75 basis points, versus about 44 basis points for ETFs, the “excess return” to ETFs is falling.

What’s more, the rapid expansion of ETFs coincided with bull markets. Index performance largely dictated security selection, and asset allocation meant little more than piling into stocks, bonds, and credit. But those days are probably over. Further sustained market advances are unlikely, given stretched stock and bond valuations, slowing economic and earnings growth, and heightened political and policy uncertainty. Broad market returns are likely to be lower, with episodes of volatility probably more frequent.

In a world of lower returns and a narrowing fee gap between active and passive investment vehicles, investors must shift their emphasis from cheap market access to proper portfolio construction. After all, the choice of which asset-allocation strategy to pursue determines most of an investment portfolio’s return. Other factors, such as tactical asset allocation or the choice of instrument, are of secondary importance and may account for less than 10% of portfolio variance.

The biggest mistake investors could make in today’s environment is to seek a safe haven in “balanced” portfolios of stocks and bonds. Both asset classes suffer from unattractive valuations and deteriorating fundamentals. It beggars belief to think that holding a roughly equal proportion of each will deliver satisfactory results.

Instead, investors must recognize that lower risk-adjusted returns – as reflected in falling Sharpe ratios – and shifting market correlations place a premium on genuine diversification and loss avoidance. Diversification requires investors to pay attention to market, factor, and non-directional sources of return, and also to focus on volatility and correlation. Avoiding losses calls for flexible decision-making to cut exposures when necessary.

Some of the instruments that investors need to diversify and avoid losses may well be low-cost. But many of them, including long/short or alternative risk-premium strategies, are unlikely to be found in the ETF universe. A blended approach is therefore likely to provide the greatest diversification benefits.

Rather than worrying about whether their portfolios are actively or passively managed, investors should focus on the crucial decision of strategic asset allocation. The tired active-passive investment debate has run its course. We truly are all active investors now.

Copyright: Project Syndicate, 2019.


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Following reverse listing, public can now acquire shareholding in Paratus Namibia


20 February 2020, Windhoek, Namibia: Paratus Namibia Holdings (PNH) was founded as Nimbus Infrastructure Limited (“Nimbus”), Namibia’s first Capital Pool Company listed on the Namibian Stock Exchange (“NSX”).

Although targeting an initial capital raising of N$300 million, Nimbus nonetheless managed to secure funding to the value of N$98 million through its CPC listing. With a mandate to invest in ICT infrastructure in sub-Sahara Africa, it concluded management agreements with financial partner Cirrus and technology partner, Paratus Telecommunications (Pty) Ltd (“Paratus Namibia”).

Paratus Namibia Managing Director, Andrew Hall

Its first investment was placed in Paratus Namibia, a fully licensed communications operator in Namibia under regulation of the Communications Regulatory Authority of Namibia (CRAN). Nimbus has since been able to increase its capital asset base to close to N$500 million over the past two years.

In order to streamline further investment and to avoid duplicating potential ICT projects in the market between Nimbus and Paratus Namibia, it was decided to consolidate the operations.

Publishing various circulars to shareholders, Nimbus took up a 100% shareholding stake in Paratus Namibia in 2019 and proceeded to apply to have its name changed to Paratus Namibia Holdings with a consolidated board structure to ensure streamlined operations between the capital holdings and the operational arm of the business.

This transaction was approved by the Competitions Commission as well as CRAN, following all the relevant regulatory approvals as well as the necessary requirements in terms of corporate governance structures.

Paratus Namibia has evolved as a fully comprehensive communications operator in Namibia and operates as the head office of the Paratus Group in Africa. Paratus has established a pan-African footprint with operations in six African countries, being: Angola, Botswana, Mozambique, Namibia, South Africa and Zambia.

The group has achieved many successes over the years of which more recently includes the building of the Trans-Kalahari Fibre (TKF) project, which connects from the West Africa Cable System (WACS) eastward through Namibia to Botswana and onward to Johannesburg. The TKF also extends northward through Zambia to connect to Dar es Salaam in Tanzania, which made Paratus the first operator to connect the west and east coast of Africa under one Autonomous System Number (ASN).

This means that Paratus is now “exporting” internet capacity to landlocked countries such as Zambia, Botswana, the DRC with more countries to be targeted, and through its extensive African network, Paratus is well-positioned to expand the network even further into emerging ICT territories.

PNH as a fully-listed entity on the NSX, is therefore now the 100% shareholder of Paratus Namibia thereby becoming a public company. PNH is ready to invest in the future of the ICT environment in Namibia. The public is therefore invited and welcome to acquire shares in Paratus Namibia Holdings by speaking to a local stockbroker registered with the NSX. The future is bright, and the opportunities are endless.