Your Quarterly E-Zine
Edition 11 • December 2019

This website contains the latest edition of Forsyth Barr Focus, a quarterly on-line magazine written by senior members of Forsyth Barr's investment team.

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GO WITH THE FLOW

Going with the crowd feels safe. In the world of managed fund investing, it’s generally accepted that there has been a noticeable shift in investment behaviour in recent times, towards low-cost (also known as passive) investment products.

This perception is clearly illustrated by the flow of funds away from actively-managed towards passively-managed products.

In the fixed interest world, there is a saying that “no amount of interest can compensate for the loss of principal”. In an era of generally rising markets, passive investing in this context has tended to deliver index performance at a lower cost, much to the satisfaction of many passive fund investors.

This phenomenon explains a lot of recent global sharemarket volatility. The other observation we can make, is that passive investment fund out-flows are correlated to negative market returns. This suggests that retail investors in passive investment funds have a lower tolerance for risk.

Source: Forsyth Barr analysis

Source: Forsyth Barr analysis

Should we worry about this impacting the New Zealand market?

There are a number of reasons why this passive investment fund phenomenon could have a negative impact on our local market:

  • Investment flows impact the New Zealand market and the level of foreign investment in New Zealand is currently higher than normal.
  • We estimate the level of passive institutional shareholder investment (share ownership) to comprise around 10% of the New Zealand market capitalisation.
  • Similar to international evidence, most of the passive investment tends to be dominated by index-tracking funds, followed by income and low beta investment strategies. Accordingly, more of the passive investment is held amongst the larger companies comprising the New Zealand market.

Source: Forsyth Barr analysis, Bloomberg

Source: Forsyth Barr analysis, Bloomberg

However, there are also a number of reasons why the impact of the passive investment phenomenon may not be significant:

  • New Zealand and Australian institutional investors, for all intents and purposes, invest based on fundamentals. That means that where New Zealand companies offer sufficient value, based on traditional valuation models, Australasian investors generally provide support by owning shares in these companies. This factor is also true of an estimated 50% of international holdings of New Zealand shares.
  • However, these active funds may be a double-edged sword. If the fundamental value doesn’t stack up and other investment opportunities become more attractive, these investors may sell their holdings.
  • Of course provided fundamental investment factors stack up, these investors will provide a degree of market stability, should passive fund investors take fright.

In summary, fundamental valuation factors remain important. Investment flows may create volatility, but as sufficient groups in the New Zealand market are largely focused on fundamental value, retail investors should continue to take advantage of sharemarket opportunities when they present themselves.

Brian Stewart
Senior Analyst, Strategy

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