Fund results out today from S&P are not good for active fund managers:
- The majority of Australian actively managed funds in all categories (equity and bonds) underperformed their respective benchmarks. This is the first time this has occurred across all categories in a calendar year since the first SPIVA Australia report was published in 2009.
- Less than one-quarter of Australian equity funds outperformed their relevant index benchmarks in 2016. This is worse than the results in 2015 and the longer-term trends observed.
- The performance of Australian mid- and small-cap equity funds was significantly worse than longer term trends. More than 8 out of 10 (81.7%) of Australian mid- and small-cap equity funds (81.7%) failed to beat the relevant benchmark index (the S&P/ASX Mid-Small) in 2016, with an average gain of 9.0% (vs 15.7% for the index). This contrasts with trends over the past 5-10-years, when less than half of funds in this category were beaten by the benchmark.
- Almost 8 out of 10 Australian large-cap equity funds (76.4%) failed to beat the relevant benchmark index (the S&P/ASX 200) in 2016, with an average gain of 9.2% (vs 11.8% for the index). Over the 5- and 10-year periods, 69.9% and 74.3% of funds in this category were beaten by the benchmark, respectively.
- International Equity funds remained among the worst-performing categories in 2016, with 86.0% of funds lagging the relevant benchmark (S&P Developed Ex-Australia LargeMidCap).
- Australian bond and A-REIT funds also continued to perform poorly in 2016, albeit with improvements over longer term trends, with more than 6 out of 10 funds across these two categories failing to beat their relevant benchmark indices (S&P/ASX Australian Fixed Interest 0+ and S&P/ASX 200 A-REIT).
OK. I am an active investor and so this is a tough one to defend.
I have a gripe with S&P’s methodology, in that S&P compare active funds including fees with index results not including fees. If you want to invest in an index, it is going to cost you something. As a side note, for any long term studies you see in this area, index fees are a big issue – the first index funds in the 1970s had massive fees.
Gripe aside, it is not enough to reverse the result. My rough calculations from the data is that over 5 or 10 years that you will find around half of active funds outperforming a comparable index fund after fees. Which is not great.
And performance over the last year is not defendable. Three-quarters of active funds underperformed a comparable index fund.
Who is the real winner?
In the end, the market has to add up – i.e. if someone is outperforming then someone else must be underperforming.
My broad brush is that:
- Professional managers as a group (there are big differences in individual funds) tend to outperform. Then, (as a group) they extract most most of the outperformance back in fees.
- Index funds slightly underperform (due to fees)
- Individual investors underperform (although there are big differences in individual investors).
- The guys taking the fees win every time…
So, Active or Passive?
I personally prefer active, as long as the fees are reasonable and the strategy is sound I think you will win in the long run. I also think there are benefits from tailoring the active share allocations with the asset allocation.
But, are there active fund managers who will take any outperformance in fees? Absolutely. If you are paying your investment manager 2 and 20 then the odds of you underperforming are high unless your manager is exceptional.
As the above study suggests, choosing to stick with passive is not a terrible option. You will never do better than average, but you won’t do worse either.
Asset Allocation is really, really important
Regardless of whether you choose active or passive, the bigger decision is asset allocation.
There is no “passive” option here. There isn’t an “index” that takes the decision away from choosing whether to invest in cash, bonds, domestic shares or international shares.
The closest you can get is a “strategic” asset allocation, which basically looks at long-term averages. But you may have to wait a long time to get average returns – strategic asset allocation doesn’t consider currency or bond rates and the risk of investing at the wrong point in the cycle. It could be 10 or 20 years before the averages revert.
I’m guessing that’s why a lot of readers are here in the first place – to get the information to make an informed decision about the macro environment, then to use that for asset allocation.
Damien Klassen is Chief Investment Officer at the MB Fund launching in April 2017. Register your interest now (if you haven’t already):