The Great Migration


18/10/2016 10:39:08 PM // Written by Phil Stockton

The Great Migration

Two powerful trends are reshaping the entire financial industry:

  1. A whole shift from active to passive; and
  2. A related trend from high cost investments to low cost investments.

In the last few years Private Capital Limited has steadily been exiting traditional active funds in favour of lower cost passive funds. In our Q3 2016 client note we wrote to our key stakeholders (the people that entrust us with their money) to advise that this process was gaining momentum and that we will fully exit all active funds in the near-term.

This is not something we have decided on a whim nor is it a decision that was taken without careful and full consideration. It is worth noting that major active fund groups are coming to the same conclusion as was evidenced in the recent announcement regarding a merger of Janus Capital Group and Henderson Group. ‘They’ have seen the ‘writing on the wall’ and acted to avoid the inevitable. I urge you to read a neat Bloomberg piece on this merger; you can find the link at the bottom of this piece. I shamelessly named this blog having read that article. Thank you, Bloomberg (and JT)!

OK, back to our Q3 2016 note which can be found in full below:

“At the end of March markets had come off a notable bout of volatility and participants probably expected more of the same was ahead. As it turns out, all things considered, the last six months have been really quite steady (notwithstanding Brexit). In the last twelve months CNN’s Fear & Greed Index has swung from ‘Extreme Fear’ to ‘Extreme Greed’ and presently sits between the two at ‘Neutral’.

Source: http://money.cnn.com/data/fear-and-greed/
 

What does this tell us? Perhaps, if investors could control behavioural tendencies, the ebbs and flows of market volatility are of less import to the longer-term investor.

On the assumption that a given portfolio suits an individual’s attitude to investment risk, their capacity for loss and their goals/objectives, then one, in theory, can be more sanguine about market movements and focus on things that one CAN control.  It is with this in mind that we have been working hard on cost control over the last year. Initially the focus was on the platforms we can use and has of late turned to the individual investments we can hold. Historically, Private Capital Limited had our roots in the ‘active management’ camp; over the last 5 years we have had a pronounced swing to passive or index funds. Over the summer we have worked on this theme extensively and have resolved to push on with the transition to lower cost Index Funds and selected ‘non-index’ Institutional fund classes.

ETFs and Index Funds have become hugely popular. They are cheap and track returns to the target benchmark less their minimal fees. This is fine but surely there is a way to get ETF type costs PLUS a ‘little extra’ on top of market returns? Well there is and it is called factor based or asset class investing - targeting identified dimensions of expected return. Both iShares and Vanguard now offer low-cost factor/asset class ETFs and there are also Institutional asset allocators offering similar exposure via conventional low-cost mutual funds. One such Institutional firm has being doing just this for over 35 years.

Professors Eugene Fama and Ken French devised the Three Factor Model as a way of capturing these ‘dimensions’ (Market, Size and Price) of expected return. Since then an additional ‘dimension’ (Profitability) has been identified and proven to be a sustainable way of adding returns over holding the ‘total market’.

The following graphic details the ‘dimensions’.

 

Many of the greatest advancements in Finance have come from academia – and significantly fewer from Wall St (let’s not mention CDOs and the like). Some of the stand-out academic advancements can be seen in the below graphic.

 

 

This is a significant evolution for Private Capital Limited and we will communicate in detail with our clients in the coming months as we move towards implementation. We hope this introduction to the ‘dimensions’ of expected return has been of interest. 

That is all for this quarter. As always, you are most welcome to contact us should you have any questions relating to your portfolio, discretionary mandate or the markets.     

PCL: September 2016”

These are interesting times for Private Capital Limited and the entire industry, we will be writing an awful lot more on this topic for a long time to come. In the meantime here is the above promised Janus and Henderson merger article.

If you have any questions, comments or observations about anything mentioned above then please do let us know.

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