Index Investing versus Active Investing Average market return at minimal cost versus the out- performance of market return, but at cost (transactional, research & management fees). Are the returns from active investing sufficient to cover the cost thereof to beat the market index? Are the track record of active managers persistent ? Over the long run, which strategy is the better?

To think about… Active investing is a zero-sum game –Net result of “winners” and “losers” yields the market average Over time markets are efficient –Short-term opportunities exist to outperform the market, but out- performance is not necessarily consistent over time Diversified risk versus concentrated risk (tracking error) –Active managers deviate invariably from the market index

The Active Manager’s dilemma SectorMarket Index Weight Manager’s Portfolio Market Performance Manager’s Performance Resources201015%17% Industrials %9.5% Consumer Goods20255%7% Services20 7.5%9.5% Financial25 7.5%9.5% Information Tech55-5%-3% Total Return7.88% 9.00% In a diversified market environment the active manager would be able to show off his/her skill for superior stock selection and/or timing, but we don’t “live” in perfect equally-weighted markets… The active manager achieved superior returns compared with the market average and … out- performed the market!

The Active Manager’s dilemma (continued…) SectorMarket Index Weight Manager’s Portfolio Market Performance Manager’s Performance Resources401015%17% Industrials %9.5% Consumer Goods %7% Services %9.5% Financial %9.5% Information Tech55-5%-3% Total Return9.56% 9.00% The active manager achieved superior returns compared with the market average, but… under- performed the market! The reality is concentrated markets!

The Active Manager’s dilemma (continued…) In concentrated markets (as in South Africa) active managers invariably will take large bets against the market index – some years it will work for them, in other years against them, but it remains risky business…

Results from a recent study* Over time index and active investing repeatedly replaced one another as the dominant investment strategy. *MBA research project by DR Wessels, 2004, titled: “Active Investing versus Index Investing: An Evaluation of Investment Strategies”

Results from a recent study (continued…) Over time index investing would have yielded on average between the 60 th - 70 th percentile of active investing returns, which is in fact an above-average return.

Results from a recent study (continued…) In search of the magic alpha…

Results from a recent study (continued…) The persistency of active investing performance… Likelihood that a top performer now will be a top performer next quarter

Results from a recent study (continued…) The persistency of active investing performance… Likelihood that a top performer now will be a top performer in three years time

Results from a recent study (continued…) Optimal results (reward-to-risk) would have been achieved when combining both strategies in your overall investment plan

Results from a recent study (continued…) An optimal allocation of index and active investing strategies, based on the performance of active managers over time. Expected Performance Percentile Active AllocationIndex Allocation 70 th 16%84% 75 th 22%78% 80 th 67%33%

Conclusion No guarantees can be given where your actual active returns are going to be in the total return spectrum, therefore follow a more prudent, conservative strategy – include an index approach.