What is passive investing?
Passive investing is a strategy used by investors to buy and hold a diversified mix of assets with the goal of achieving returns that mirror a particular market index. This approach requires minimal buying and selling, as the primary objective is to match the performance of an index like the S&P 500 or the S&P US Dividend Growers Index (which the Vanguard Dividend Appreciation ETF tracks, but more on the specifics later).
Passive investing has its benefits, such as its lower fees and simplicity in approach. This approach is also less time-consuming for investors, as they don’t need to actively track or make decisions about individual securities. Furthermore, the “buy and hold” strategy means fewer transactions, and thus creating longer term sustainable growth.
On the downside, passive investors give up the possibility of outperforming the market since their goal is merely to match it. In rising markets, passive investments will grow, but they will also fall in line with market downturns. Moreover, passive funds can become victims of their own success. If a significant amount of capital flows into an index, the underlying stocks may become overvalued, leading to potential market inefficiencies.
However, Vanguard uses a rules based approach and as such there is no active stock picking. The ETF has 314 constituents that are annually screened for their financial health based on specific criteria. This rules based methodology, ensures quality, instead of chasing higher (riskier) yields.
As mentioned earlier, the ETF tracks the S&P US Dividend Growers Index and the criteria for inclusion (of stocks) in ETF are as follows:
- Sufficient liquidity, making it easier to enter or exit positions (for traders) without affecting the market price of the share.
- Annually, all eligible companies are ranked by indicated annual dividend yield (IAD). Where each constituent has to show increasing dividends over a period of 10 years.
- Furthermore, the top 25% (15% for existing constituents) highest-ranked companies are purposely excluded to mitigate risk, as the highest dividend paying companies may potentially struggle to maintain an increasing dividend pay-out. The remaining eligible companies constitute the index, while individual constituent exposure is capped at a (max) weight of 4%. This method ensures constituents are stable and consistently profitable companies with a proven long term track record of dividend growth.
Now how does active compare to passive investing strategies?
Active investing involves making specific investment decisions with the aim of outperforming an investment benchmark index. Active investors, whether they are individuals or professional portfolio managers (Ninety One, Lindsell Train, Ballie Gifford to name a few), make buy, sell, or hold decisions based on a combination of factors such as their analysis of individual company performance and news, market forecasts, and their own judgement.
The primary benefit of active investing is the potential to outperform the market. In specific market conditions or sectors, skilled managers (like Clyde Rossouw) may identify opportunities or risks before they are reflected in market prices, thus capitalising on short-term price discrepancies. Active management also offers the flexibility to make tactical decisions based on current market conditions, geopolitical events, or company-specific news.
However, active investing can be more costly due to higher transaction/management fees. There’s also the risk that the manager’s decisions may not always lead to superior returns, in other words they are more volatile. However, by combining both passive and active strategies in a portfolio, investors can aim to benefit from the consistent returns of passive investments while potentially capitalising on the opportunities provided by active management. This blended approach offers diversification, manages risk, thus helping investors reach their long-term financial goals, in a more effective manner.
So why Vanguard Dividend Appreciation ETF (VDA)?
Simply put, We are big believers in dividend paying stocks, as the investor profits in two-ways. The first is the appreciation of the stock price, while the second is through the distributions made by a company. Should share prices be under pressure, distributions ensure a regular (dividend income). Therefore, having a defensive position is fundamental in acting as a shock absorber against material market downturns.
Ultimately, we believe this will lead to more consistent and stable long-term returns as shown in the chart below.
As mentioned earlier, the performance figures of the VDA ETF will not outperform its benchmark due to its passive investment strategy. The ETF tracks the S&P Dividend Growers Index, as set out in its investment objective, and takes a quality approach to equity income instead of chasing higher (riskier) yields. Its profitable and established constituents protect the portfolio from extreme swings in volatility.
As you can see, there is a general theme trending here at InvestLife….we like quality! Whether it is active managers like Clyde Rossouw or passive rules based ETFs like the Vanguard Dividend Appreciation, we are firm believers in investing in quality, from quality stocks, to quality mutual funds, to quality ETFs.
I trust this Friday’s Fund Review of the Vanguard Dividend Appreciation ETF provided you with some insights into the value of having passive investments in your portfolio. As well as, the benefits of blending both passive and active investment strategies to help you, the investor, achieve consistent and stable long term growth in your portfolio.
Now it’s time to watch the Springboks blend their perfect mix of passive (the forwards) and active (the Backs) , as they dominate in this world cup, GO BOKKE!
