Mario Fisher,
For years, investing has been seen as a choice between two clear-cut options: passive strategies or active management. Passive investing offers low costs, transparency and market matching returns. Active management, on the other hand, strives to deliver outperformance through intensive research and stock selection. Today, that binary view is changing. Investors are increasingly discovering that the most exciting opportunities lie in the space between these two extremes.
Systematic investing, factor-based strategies and smart beta portfolios are reshaping the traditional landscape. This growing middle ground combines the discipline and cost-efficiency of passive investing with the targeted enhancements traditionally linked to active management. It’s becoming one of the most influential developments in modern portfolio construction.
Compelling reasons for growth of passive strategies
Passive investing has seen massive growth over the past two decades, and the reasons are simple and compelling. Traditional active managers, on average, struggle to consistently outperform benchmarks after fees. Investors increasingly questioned why they should pay high fees for performance that often resembled the index anyway. Passive investing addressed these concerns directly through lower fees, greater transparency, predictable benchmark exposure, and low stock selection risk. In South Africa, exchange traded funds (ETFs) and index-tracking portfolios have become increasingly popular among both institutional and retail investors. Passive strategies provide efficient market exposure and have proven particularly attractive in an environment where many active managers struggle to consistently outperform benchmarks after fees. However, passive investing also has its limitations. A passive portfolio simply accepts the market as it is. It does not distinguish between expensive and cheap shares, profitable and weak businesses, or concentrated and diversified exposure. Indices weighted by market capitalisation can become heavily concentrated in dominant sectors or stocks, creating unintended risks for investors. Passive investing results in market-like returns, subject to frictional costs but never market outperformance. For investors seeking enhanced long-term returns, downside protection or improved risk-adjusted outcomes, pure passive exposure may not always be sufficient.
These limitations have sparked growing interest in approaches that remain systematic and rules-based, but which intentionally improve upon traditional benchmark construction.
The value of active investing
Despite the rise of passive investing, active management remains important. Skilled active managers can still add value through fundamental research and stock selection. This is particularly prevalent in less efficient markets, including many emerging markets and segments of the South African market, where active insight can matter significantly. South Africa presents a unique environment. It is a relatively concentrated market with variable liquidity across the market cap spectrum, uneven analyst coverage, and macroeconomic volatility. These conditions can create opportunities for differentiated active strategies.
However, active management also faces structural challenges, including higher fees, manager selection risk, style cyclicality, and inconsistent long-term outperformance. Many investors and allocators have learned that identifying the outperforming active managers in advance is exceptionally difficult. Even relatively strong active managers can experience protracted periods of underperformance compared to benchmarks.
Where the sweet spot emerges
Given the limitations of both passive and active strategies, investors increasingly seek approaches that retain the discipline and scalability of passive investing while systematically targeting the drivers of long-term excess returns. This is where the sweet spot begins to emerge. Smart beta strategies remain rules-based and systematic like passive investing, but intentionally deviate from traditional market capitalisation weighting to pursue better risk-adjusted outcomes. Rather than relying on discretionary judgement like fundamental active management, factor investing targets persistent drivers of long-term returns identified through academic and empirical research. Common factor drivers include value, quality, momentum, low volatility and size. These factors have historically delivered excess returns or improved portfolio efficiency across different markets and economic cycles.
Systematic factor investing combines several attractive characteristics. It has lower costs than traditional active management, rules-based transparency, process consistency, scalability, and reduced behavioural bias. Simultaneously, it provides investors with intentional exposure to proven return drivers rather than simply accepting benchmark-construction methodologies. The appeal of systematic investing lies in balance. Investors no longer need to choose exclusively between low-fee passive market returns after frictional costs and expensive discretionary active management. Instead, they can access portfolios that remain disciplined and transparent, control costs, and seek enhanced returns through systematic factor exposure. This is particularly compelling for institutional investors. Retirement funds and long-term allocators require repeatability, scalability, governance, and cost efficiency. Systematic factor strategies naturally align with these objectives.
The future of investment management
In South Africa, systematic factor investing can also help address concentration risks embedded in local equity benchmarks while maintaining broad market participation. The future of investment management is unlikely to be purely passive or purely active. Instead, portfolios are increasingly combining systematic core exposures, smart beta allocations, and selective active strategies. Each has a role to play. Passive investing remains an efficient base for broad market exposure. Active investing continues to offer differentiated opportunities in specialised areas. However, systematic factor investing provides a compelling middle ground that combines many of the strengths of both approaches.
As fee compression, technology efficiencies and investor sophistication continue to evolve, this sweet spot in between provides a powerful mechanism for building resilient and efficient portfolios.
Mario Fisher, Chief investment officer of systematic strategies at Momentum Asset Management
