‘Nobody delivers Madoff-style returns’

Only 10 per cent of the Australian managed funds that outperformed their benchmark index in 2014 were able to do so consistently for the following two years, according to research by S&P Dow Jones Indices.

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But fund managers have hit back, saying they shouldn’t be expected to deliver “Bernie Madoff-style” returns quarter after quarter.

The S&P persistence of performance research has been conducted for a number of years in the US, but it’s the first time it has focused on local fund managers. The staggeringly low figures of managed funds able to consistently beat their index, or even to operate in the top quartile of managed funds, are another front in the war between passive and active investment vehicles.

There has been a rise in recent years of exchange-traded passive funds designed to mirror the composition and thus performance of the broader index. Billions of dollars globally have flowed to these passive vehicles from managed products, which charge far higher fees on the understanding that they’ll steer clients’ money towards the more profitable parts of the market.

As of December 31,the Australian passive industry managed $25.6 billion in funds, up $2.5 billion on a year earlier, according to VanEck.

According to S&P’s research, of the 122 large-cap Australian equity managed funds that outperformed their index in 2014, only 12 continued to do so in both 2015 and 2016. Four consistently rate

Top fund managers didn’t perform poorly compared with the index, but also compared with the performance of other funds, with the funds able to post largest gains one year rarely able to hold on to that position for any length of time. Of the 180 funds to perform in the top quartile of all Australian managed funds in 2012, only four , or 2.2 per cent, achieved consistent top-quartile performance every following year to 2016.

S&P’s Priscilla Luk, who heads up the firm’s Asia Pacific research and conducted the study, said fund managers know performance is hard to achieve. “What they’re surprised by is just how rare it is.”

Australian-managed funds, she added, actually performed relatively better than US-focussed funds when it came to persistent performance – a factor she attributes to the generally greater competitiveness of the much larger US market and to the relatively lower volatility of Australian equities. “If you’re in a less volatile market, you don’t need to reposition between defensive and aggressive regimes so much – that might help you be more persistent in your performance,” she said.

But even so, the figures are low.

They’re unlikely to be helped by the fact that 2016, the final year in the analysis when previously high-performing funds suffered the most, saw heavily rising global markets. Ms Luk points out a clear tendency for managed funds to outperform the market when it is falling or treading water, while struggling to match the performance in boom times.

Fund managers are hitting back. ‘Knock the lights out’

Will Low, Nikko AM’s head of global equity, said it was unrealistic to expect managed funds to outperform every single year, as some markets favoured certain investing styles over others.

“Nobody delivers Bernie Madoff-style solutions where you guarantee, each and every quarter, each and every year, you’re knocking the lights out,” he said.

“Sometimes your strategy doesn’t perfectly fit into the Gregorian calendar. And if you start managing your strategy to do so, you end up chasing the same behaviours as everyone else. Sometimes your longer term thesis doesn’t play out in the short-term, because of thematic or irrational behaviours ??? If you underperform the odd year, that’s perfectly normal.”

Although few argued all fund managers deserve their fees.

“The average fund manager has undoubtedly, over the long term, underwhelmed”,” Mr Low said. “In our industry, there’s increasing differentiation between those delivering active portfolios, who over time outperform the benchmark, and those who are not.”

Romano Sala Tenna, portfolio manager at ASX-focussed fund manager Katana Asset Management, said “at the end of the day, you’ve got to be assessed on how you add alpha – otherwise, why are we there?”

But he too questioned it was possible to deliver out-performance every single year.

“I don’t think it’s possible to maintain that level of performance over an extended period of time. You’d have to be constantly reinventing your portfolio to pick up the next wave in investor sentiment, probably constantly changing investment style.

“If you’ve got confidence in a fund manager, and you have confidence in their process and experience, sometimes after a bad 12 months, it can be the best time to invest. A good fund manager, if they’ve kept investment team intact, can do well after they’ve had a bad year.”

Bennelong Australian Equity Partners is an Australian-focused, managed fund tagged as one of the best-performing in Australia, according to the Mercer rankings. But it underperformed the index by almost 6 per cent in the second half of last year due to its relatively low exposure to cyclical stocks, which surged on the Trump trade to a far greater extent than the growth companies Bennelong favours.

Its investment director, Julian Beaumont, said standout fund managers tend to be “high-conviction” outfits – with concentrated funds heavily invested in a few key calls. Because of this, they’re highly vulnerable to major lifts outside these equities, but the style “tends to do well over time, generating returns over the long term”. ‘Hugging the index’

He said he’s not surprised by the low persistence of Australian funds.

“The Australian market is really concentrated within the top 20 [stocks],” he said. “A lot of typical all-cap fund managers will hold those top 20 in big weights – your CBA, Woolworths, BHP and the like.”

With so many fund managers “hugging the index”, he said, any who steered away from it risked getting whacked by broad changes in the market that aren’t reflected in their stocks. Because of management fees of “up to 1 per cent” charged by most funds, any underperformance of the index is highly risky.

“With management fees of up to 1 per cent, they have to make up the index then beat it,” he said.

It’s this type of fund management, Mr Beaumont said, that was most under threat from the rise of passive investment vehicles.

“As money flows into index funds and what-not, you’ve taken a lot of ‘dumb money’ that has accepted it can’t beat the market, that’s gone into passive funds.

“It makes a really good case for funds that aren’t mirroring the index, who are prepared to go into the stocks not in it – IPOs, mergers, small caps and the like. That’s where the opportunities are.”