Fundies have a shocker

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):

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  1. I’d like to see work done on the volatility of those same returns v the benchmarks though. In theory they should be close if the fund tracks a benchmark but who knows.

  2. ” … choosing to stick with passive is not a terrible option. You will never do better than average, but you won’t do worse either.”

    Mate, really……………of course :

    1. Given the outcomes, it’s so very apparent that passive is actually a ‘marvelous’ option, rather than your conveniently described ‘not terrible option’ ( personal credibility issues raised when you describe it as such – you not writing to kids );

    2. The outcomes do very little indeed to support investment in the proposed MB Fund ;

    3. Your efforts here do nothing to support investment in the MB Fund as proposed ( given the support for ‘active’ management);

    4. The fact that you yet support active management in the face of consistently bad results from these type of managers is disconcerting ;

    5. No amount of rhetoric from yourself in attempted support of active mamangement ( eg, it’s the asset allocation issue) will be considered sufficient ;

    6. The only rational conclusion here is that one should go for passive, index-styled investment ;

    7. Huge problem then is :” Why pay for someone to hug the index, I can do that myself ” … that’s the conundrum for one starting out advertising their intended portfolio-management services ;

    8. See what Warren Buffett had to say when/after he took that bet in relation to active vs passive portfolio managers … in actual fact encourage your readers to view the outcome of that Warren Buffett bet ;

    9. Mate … you have some real work to do attempting to convince … please don’t go down the ‘asset allocation’ attempted support route = why should you believe you have superior asset allocation skills.

    10. In terms of risk and return, buy the index funds .. period … the evidence is there, sorry…you have highlighted it by your post above, also. Additionally check the Warren Buffet bet, OK…. refer :

    Cheers and good luck.

    • To be honest, just because most fund managers lose to the index, it doesn’t mean everyone does. The MB fund may beat the index after fees, but it’s not likely. Especially with a macro approach – very few can do that well.

      Back to the article:
      “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”

      I call BS. The fees/spread on vanguard funds in Australia are quite good to be honest. Better than any fund manager will give you.

      • I’m the first to admit that the fees on current ETFs/index fund are great. Some of the US ones are now below 10bps.

        My point on the longer term studies is not BS. There are long term studies talking about how much better you would have done buying index funds over 40 or 50 years. The first index funds in the 1970s had fees of around 5%, plus trading costs were much higher.

        My point is that these studies should compare apples with apples – look at both index and active after fees. Which is what I have tried to do…

      • Hoborg: Refer my final numbered point in terms of “risk and return” – that should assist in terms of your obviously-stated first sentence issues.

        Damien: Yet to respond in terms of persuasion, in my view, as regards particular fundamentals raised in my post.


      • Mark HeydonMEMBER

        “just because most fund managers lose to the index, it doesn’t mean everyone does”

        Is it any easier to select the manager who isn’t just lucky than it is to select the stocks in the first place? I’d argue not.
        And then there may be those who are skilled at picking fund managers, but how would we distinguish them from the purely lucky?

        It’s turtles all the way down.

    • Passive and active both suffer from the same thing… everyone has forgotten how and when to sell. There is no real trading fund that I can find in Australia ( consistently holding 30% cash ). Everyone thinks credit and hence asset prices will rise to infinity and all they have to do is BTFD. We are all central bank followers now.

    • Thanks for the comment Uptown Funk – my point wasn’t to spruik the MB fund… Let me be clear:

      1. I completely agree that if you are looking for average (after fees and trading costs) performance, then index funds are a great option. They are cheap, and you will only slightly underperform the headline index.
      2. Don’t under-estimate your asset allocation decision. You will probably make or lose more with that decision than you will with your active vs passive call.
      3. When I’m blogging I’m trying to inform, not sell. If you want to call me out for trying to spruik to you then I’ll accept that criticism. I find it amusing that most of your points seem to be complaining that I’m doing a bad job spruiking!

      • Damien,

        You print: ” I find it amusing that most of your points seem to be complaining that I’m doing a bad job spruiking! ”

        Really, you then must be one of those crazy persons walking down the street laughing at nothing in particular.

        Nothing that you have hereby provided enhances matters at all.

        Please don’t reply, thanks.

  3. If the fundies had only invested in the private monopolies created by governments selling off ownership of vital infrastructure or tendering for new infrastructure and services, they’d be sitting pretty. Today, in the Herald-Sun, one J Kennett is decrying the rip-off of the public being perpetuated by City Link on motorists. He is accusing the Andrew’s government of rolling over and saying that the deed he signed 21 years ago should be adhered to. Well, Jeffrey, I’d like to see that, you see, because of Big Australia people like yourself, Melbourne has been growing around about 3 to 4 times as fast as it used too, and new infrastructure is needed as of yesterday at a phenomenal and growing rate. Do you think City Link are unaware that Melbourne desperately needs new infrastructure because of its rampant population Ponzi economy? I’d like to see what would happen if Andrews challenged City Link in the courts. Everything would be held up for years and only the lawyers would win and Melbourne would be in an even more desperate state. Well done Jeffery. City Link now has the state government over a barrel because YOU signed that contract 21 years ago. You were warned !

    And here he is, the Pot, Jeffery, calling the Kettle, Andrews, black:

  4. Even StevenMEMBER

    Damien – you can get index funds which are free of ongoing management fees – refer Macquarie True Index Fund series.

  5. Active looks even worse when forced to show ‘after tax’ returns; this reporting quite rare in Straya. Vanguard does though. It’s quite sad that the marketing material used by the fundies get to eliminate the large impact of taxation. Lazy ASIC should require this in the spirit of ‘full’ disclosure. The SEC (USA regulator) has mandated this since 2001.

    Good luck with beating the ‘market– most don’t. In this S & P study, 86 /100 failed the mission.

    Note: Will never forget a <mediocre Sydney manager who lived up Pymble way explaining at a BBQ his 'job' was to put the 'fun' in funds management. Their chubby MER underwrote a lot of 'fun' that day included.

  6. Noticed this at The Australian

    Magellan Global Equities Fund: Fee 1.35%. One year return 2.75%.
    Vanguard US Total Market Shares Index ETF: Fee: 0.05%. One year return: 13.42%
    Vanguard All-World ex-US Shares Index ETF: Fee: 0.13%. One year return: 7.45%

  7. investing in the index is only good so long as the index you are investing in goes up.

    Nikkei & ASE stock exchange anyone?

  8. “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.”

    You do understand that this is a tautology, don’t you?

  9. Are you sure you aren’t talking your own book when you say that most active managers outperform but capture most of the outperformance?
    My understanding is that very very few active managers outperform their benchmark indexes over 5 years.
    The costs of active management of stock market funds to the actual retail investor are such that on a net basis over a 5 year period they should expect to underperform index funds. 10% might be lucky, but there is no reliable way to pick which 10%.
    “Active managers provide the vital functions of price discovery and liquidity, but do so at a relatively high cost.
    As a consequence, active managers do not generate excess returns after fees in the aggregate. ”
    Michael J Mauboussin
    Credit Suisse
    “Looking for Easy Games
    How Passive Investing Shapes Active Management”

    • Damien KlassenMEMBER

      I’m sure I’m not talking my own book – if I was I wouldn’t be showing these reports at all!

      You generally see two types of surveys. The first type is by the active fund managers which show that “pre-fees” active managers generally beat the index. The second type is by the index providers that show that “post-fees” the active fund managers do worse than a “pre-fees and with no trading costs” index. Both are right.

      The issue is that a “pre-fees and with no trading costs” index is not the target you should be comparing funds to. 100% of index funds underperform the “pre-fees and with no trading costs” index (because they charge fees and have transaction costs). When you adjust for that, you find that around half of active managers (in aggregate) outperform. Which is far from a recommendation for active…

      I agree with most of the CS report – noting his recommendations (although I think the “build your own index” option is beyond most investors):

      Don’t Be the Patsy. Indexing makes a great deal of sense for investors who do not have the time or
      sophistication to evaluate investment managers. This is relevant for most individuals. These investors
      should focus on allocating assets appropriately and minimizing costs.
       Seek Dispersion. Research shows that there is more opportunity for excess returns in asset classes
      where the dispersion of returns for asset managers is wide. Since markets demonstrate varying degrees
      of efficiency, it makes sense to consider the trade-off between active and passive case by case.
      Investors should also be alert to the possibility of other costs and risks, including legal and political ones,
      for apparently inefficient markets.
       More Sophisticated Search. Academics suggest that careful examination of four factors allow for a
      better probability of identifying skillful active managers.The first is an examination of past performance
      following some important adjustments for factors and random skewness in returns. Next, there is
      evidence that some managers do better in certain macroeconomic environments. Managers who are well
      educated, as evidenced by their college, SAT scores, graduate school or business school, and attainment
      of a chartered financial analyst credential, tend to outperform those who are less educated. Further,
      managers from poor families generate more alpha than those from rich families. Finally, analysis of
      fund holdings, which is difficult for unsophisticated investors to access, reveals that contrarian managers
      outperform managers who herd.

       Build Your Own Index. Andrew Lo, a professor of finance at the MIT Sloan School of Management,
      suggests that we are on the cusp of developing indexes that capture a particular investment strategy.
      He suggests that an index should be transparent, investable, and systematic. Ironically, the most popular
      index in the world, the S&P 500 Index, does not embody the third property. Lo argues that sharp drops
      in the cost of structuring and trading securities introduces the possibility of customized indexes.

  10. Isn’t one of the biggest issues here why fund managers need to have benchmarks in the first place? Generally it is so researchers can categorise them into boxes which in turn allows gatekeepers and decision makers to “approve” the fund to go on APLs and other investment menus.

    On the other hand, genuine stocking picking funds (High Conviction funds and the like) can have spectacular outperformance when they aren’t obsessed about tracking error.

  11. “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.”

    Oh dear. You do realise this is a tautology, don’t you?

  12. Even StevenMEMBER

    Damien – I’m very interested in the MB fund (and potentially would be willing to put in significant amounts in future). My rationale would be that I think you guys *are* smarter than the rest. Largely because your thinking is less ‘conventional’ than the rest.

    Beating index (after fees) is hard. It’s even harder because of higher turnover associated with active portfolios (not necessarily captured in the reported performance figures). Also, there are some index products that are completely free of ongoing fees (refer to Macquarie True Index range of funds).

    I worked in investment management previously. Whilst my research was not exhaustive, what I did see suggests that most active managers will underperform index after fees. We utilised both active and index managers so I had no inherent bias…