Reading the latest report card on Australia’s actively managed investment funds, you could be forgiven for thinking that the profession of ‘stock-picking’ has had its day.
S&P Dow Jones recently released their mid-year 2016 SPIVA Australia Scorecard and it shows that the majority of actively managed funds have had a hard time lately, with the majority failing to beat their respective benchmarks over one, three and five year periods.
One year, S&P argues, is really too short to draw any meaningful trends from, so it makes sense to look at the longer term over five years.
The S&P research found that 69.18 per cent of active Australian equity funds underperformed the S&P/ASX 200 Index over five years, 91.89 per cent of active international equity funds underperformed the S&P Developed Ex-Australia Large MidCap Index and 88.68 per cent of Australian bond funds underperformed the S&P/ASX Australian Fixed Interest Index.
Those numbers may leave some investors with the impression that actively choosing securities is an inferior method of investing to index-based management, where broad, market cap-weighted funds simply hold a representative sample of an index, like the S&P/ASX 300.
Vanguard is well-known as a leading index manager around the globe, having launched the first retail index fund back in 1976 in the US, and has benefited from the shift from active managers into lower cost index solutions.
Investors – here and overseas – are certainly voting with their wallets as funds are flowing into index products like exchange-traded funds and out of active funds.
However, a quick reality check is needed. Even with the momentum of the past five years, indexing still only represents 18.5 per cent1 of funds under management in the Australian market.
Vanguard also offers actively managed products across both shares and fixed income asset classes in the US, and we see a role for both active and index funds within properly constructed portfolios.
The active versus index debate may not be quite as polarising as certain presidential election debates, but feelings certainly run deep when results like the SPIVA scorecard are published.
To a significant degree, active managers have made the rods for their own backs. The proposition promoted heavily to investors is that they will outperform a given index by a certain margin after fees.
So it is hardly surprising in a data-driven industry that when the numbers confirm you didn’t achieve what you set out to do on behalf of your clients, some people take notice and maybe even decide to fire you and try their luck elsewhere.
The problem with the active versus index debate is that it is constantly positioned as an either/or question for investors.
The more thoughtful way for investors (and their advisers) to frame the debate is to think about how you blend both approaches to suit your risk appetite and long-term investment goals.
Vanguard refers to this as a core/satellite model, where the ‘core’ of an investor’s portfolio is made up of low-cost index funds. Having the majority of a portfolio in these reasonably predictable and cost-effective funds provides scope to select some active ‘satellite’ investments, which can provide the potential for outperformance of their respective market benchmark.
When selecting active funds, there are many aspects investors can pore over, from investment style, to security selection process, to the management team’s expertise.
As with any market-linked investment, time horizon is also a critical factor. We know from industry data that too often investors do not capture the full return that funds deliver – in fact, over a 10 year period, dollar-weighted returns for investors lagged their Australian managed fund performance in large cap equities by 5.2 per cent, and Australian small and mid caps by 7.9 per cent.
This is likely due to investors having sold out when funds are underperforming or buying into funds after they have had strong performance.
Having the patience to give an active fund time to perform is one thing, but judging whether it will indeed provide required performance is another.
One of the most effective indicators of future success is cost, because the less you pay a fund manager, the more of your returns you will keep. In fact, research group Morningstar has found that low cost is a superior indicator of managed fund performance.
In the context of cost, it is important to note that the SPIVA performance analysis is net of fees, meaning the cost of paying fund managers has already been factored into fund performance against their benchmarks.
Active management typically comes with higher costs – the asset-weighted average management fee for active funds in Australia is 0.93 per cent per annum, compared to 0.30 per cent per annum for index funds – which highlights the drag fees have on overall performance.
As an example, the average annualised return for active Australian equity funds over five years was 7.28 per cent, compared to 7.40 per cent for the S&P/ASX 200 index.
Now, imagine if that average annual active management fee halved.
It certainly begs the question of how much costs affect the net returns of active funds, and whether it is poor ‘stock picking’ skills or high management fees that are holding many active funds’ performance back.
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Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment. |
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