Portfolio

Finding alpha, beating indices getting harder in India: CFA Institute head

Anand Kalyanaraman | Updated on December 11, 2019 Published on December 11, 2019

India will soon join the rest of the world in the shift towards passive investing, says Margaret Franklin

 

In the US, investors are taking money out of active funds and putting it into index funds at an astounding rate, says Margaret Franklin, President and CEO, CFA Institute, said in an email interview. She expects India to eventually converge with the rest of the world in the shift towards passive investing. Excerpts:

Interest rates have been negative in a large part of the global economy. What are the implications? How do investors including pensioners deal with this?

Negative interest rates have a number of implications on institutional portfolios. It is a complex topic, as negative interest rates influence earnings and asset class returns through a number of channels. The prices of real assets go up as interest rates go down, and this has been reflected in the performance of public and private equity, as well as real estate markets. The specific impact on pensioners will depend on the asset allocation of their pension portfolios. For pensioners, the focus should be on real interest rates and not nominal interest rates. In a country going through deflation, a zero or negative interest rate may still be okay as long as inflation is below the nominal rate.

Increased protectionism has taken a toll on the global economy. How is this likely to play out? Is the global economy heading for a recession or are the fears overblown?

The rule of thumb for an official recession is two consecutive quarters of shrinking output and there is no evidence of this in markets at this time. The rise of protectionism is something that we are seeing around the world, but it is too early to say what impact it will have on long-term global growth.

How will AI and big data impact investments — the process and the outcome — in the coming years? Which other big investment disrupters do you see on the horizon?

The first big change is the availability of new sources of data for analysts. Analysts now can process unstructured text, images and videos, and if they don’t have the infrastructure to make use of these sources, their analysis will not be as good as the competition.

The second change, which is more of a continuation of earlier trends, is the ability to use quantitative techniques to understand factors that drive portfolio performance. This is driving product innovations like smart beta investing and reducing the space for classical active management.

Finally, AI is making slow inroads into the whole process — it is early days, and our assessment of the Asia-Pacific fintech markets shows that a few firms are using AI in their investment processes, but investments and pilots are increasing and this is a trend that will pick up in the coming years.

What are the key global trends in wealth management now?

Wealth management has changed significantly in the past few years everywhere in the world. There are two primary drivers — technology and regulation. We can see the same forces acting in India as well. Technology has made it possible to offer wealth management services to people who were traditionally not served by the industry. Robo advisory platforms are new entrants expanding the market this way.

Traditional firms have responded by creating their own platforms. Regulators have also forced significant changes to the industry in their efforts to protect the interests of customers. In the past, the industry has operated on a buyer beware philosophy — it was the investor’s responsibility to decide which product was suitable for them. Regulators in many countries are now pushing wealth advisors to take more responsibility for customer outcomes, which is a trend that we support at the CFA Institute, and one that resonates with investors in markets the world over.

The Indian economy is growing faster compared to other economies and we expect wealth management to grow even faster, as people move from physical to financial assets. It takes time for rising incomes to be translated into wealth so we can expect some lag between economic growth and growth of demand for wealth management services. Companies that focus on improving client outcomes will do better in the long term than companies that are trying to get the most short-term revenue out of their clients.

How do you see the active versus passive investing debate shaping up? Will technology further shrink the opportunities for alpha generation and hasten the shift towards passive investing, especially in markets such as India?

We expect to see increasing convergence over time between emerging markets and developed markets. It is already becoming harder to find alpha and beat the indices in India. This, combined with cost pressure, is leading advisors to recommend higher allocations to passive funds. SEBI is pushing the industry towards fee-based advice, and this is something that will encourage passive investing as well, as wealth advisors will have to pay more attention to asset management costs.

The global asset management industry has changed very significantly in the last few years as funds have been pulled out of active management and into index funds. From 4 per cent of equity mutual fund assets in 1995, passive funds grew to 16 per cent in 2005, and doubled to 34 per cent in 2015.

But the even more important trend is that since 2008, index funds have accounted for 160 per cent of the net flows into equity mutual funds in the US. What this means is that investors are taking money out of active funds and putting it into index funds at an astounding rate — from 2008 to 2016, investors have sold $600 billion of their active holdings and purchased $1.6 trillion of passive funds. We don’t know when something similar will happen in India, but eventually we expect India to converge with the rest of the world.

What are the key trends in ESG (environmental, social and governance) investing? Is it gaining more traction globally?

We do see ESG investing picking up in India. It is early days, but we can already see a few ESG funds being set up. There is more and more discussion on ESG integration in India, as there is globally. The CFA Institute is an important voice in this conversation.

We see a lot of interest from regulators in improving reporting standards in this area. We recently launched our ‘ESG Disclosures in Asia-Pacific’ report where we examined ESG reporting practices in several countries in the region, including India. And, we are in the process of convening a global working group to explore the development of a global ESG standard that would build a framework for investment managers to better communicate, and investors to better understand, the nature and characteristics of ESG-centric funds and investment strategies.

In India, companies are responding to this interest from investors and regulators by paying more attention to their own reporting practices. We are planning a series of roundtables, workshops and seminars on ESG related topics in the next few months.

Corporate governance is already well integrated into the work that analysts do. What is relatively new is the integration of the E and S – the environmental and social elements. There are definite return implications, both in terms of understanding risks arising from ESG considerations and the impact on strategy and competitiveness.

What are the diversity and inclusion initiatives being undertaken by the CFA Institute?

We have many initiatives at the CFA Institute to promote diversity. I’ll highlight our key initiative in India, which is the Young Women in Investment programme. We started this programme two years ago and it is a collaboration between ourselves and many large local and global institutions. The programme was held in Bengaluru and Mumbai and we provided an intensive boot camp for 100 young women, after which they joined a three- or six-month internship programme with one of our partners. The aim of the programme is to promote the investment industry as a career option for young women in India.

Globally, we also have the Women in Investment programme which I helped to co-found. Our aim is to promote awareness in our industry of how diversity can help promote better business outcomes. We hold an annual conference to discuss key issues, and our conference this year was in Montreal.

Published on December 11, 2019
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