Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Managers link arms to promote active strategies
A group of three big global managers has linked up to promote the benefits of active management in Australia and New Zealand, ahead of what is generally expected to be a sharemarket correction sometime soon. Active managers have been through a rough time in the past two years. In the inevitable downturn, they should shine once more.
Baillie Gifford, Capital Group and MFS Investment Management, which each has solid support from Australian and NZ investors and long track records, will host a series of forums and briefings in Australia this week to bring what they believe is greater balance, research and perspective to the active-versus-passive discussion.
Following a similar initiative by the trio in the UK in 2018, they are urging investors to adopt a more holistic view of active investing and challenge the somewhat-liner mindsets surrounding headline fees and costs. The mindset has been helped along by regulator APRA recently with its controversial “Heatmap” of colour-coded descriptions of big Australian super funds’ returns.
It’s probably the first time in Australia that a group, admittedly small, has got together to put the case for active management. They will be joined by several independent academics and economists, as well as investment strategists and portfolio managers from the three firms to sell their message.
The three Australasian country heads for the firms, Rosemary Shannon from Baillie Gifford, Paul Hennessy from Capital and Marian Poirier from MFS, say cost bias and a lack of context in the discussion have put investors at risk of over-reacting to short-term market moves and therefore missing out on long-term growth opportunities.
The market’s “intense focus” on fees – often at the headline level rather than after-tax – has generally led to a deterioration in the capital allocation decisions to actively managed assets, they say. The group has come up with an acronym for their story: ‘FACTS’. This stands for:
- FEES matter. Research shows that active managers with fees in the lowest quartile are more likely to deliver excess returns
- ACTIVE managers who co-invest in the funds they manage are more likely to deliver excess returns
- CONTEXT is an important consideration when conveying the performance of a particular strategy. For instance, towards the end of the longest bull market in history, which is where we are, active investing is more important than ever
- TIME horizons matter – long-term investment results remain paramount for most investors and are essential to create and maintain enduring wealth
- STEWARDSHIP, meaning responsibility and governance, should be embraced for the management of other people’s money over the long term.
According to a recent client note from Frontier Advisors active managers underperformed last financial year by the biggest margin for 10 years. But it’s not a simple story, hence the necessity for context. A lot of the underperformance was due to the cyclical nature of markets. For instance, active managers are more likely to invest outside the large-cap space, given they are not so driven by market-cap indices, by definition, as passive managers. Also, most active managers either underweight or do not own REITs, which outperformed strongly in the past couple of years, even though underlying property markets had come off. Performance for Australian REITS was largely driven by a yield gap because of the fall in official and bank interest rates.
Over the five years to June 2019, the median manager outperformed the ASX 300 by 1.3 per cent. Over the five years to 2014 the median manager outperformed by 1.5 per cent and over the five years to 2009 by 2.4 per cent.
Looking at a chart of the spikes in outperformance by active managers, as per the Frontier client note, you can see that in market downturns the median manager outperformed most, the outperformance peaking in 2008, 2015 and 2018. Last year was actually an outlier.
Baillie Gifford’s Rosemary Shannon agreed many active managers would outperform because of the defensive nature of their strategies, but that in the long run the key was time in the market, not timing the market. According to recent research by the Arizona State University going back 90 years, she said, almost all of the excess returns from the US stock market were delivered by only 4.3 per cent of the stocks. Long-term exposure to those specific stocks, and riding out unpredictable but inevitable short-term volatility in share prices, matters a lot more than trying to predict market sentiment. The point is indices cannot pick stocks to that degree – not even smart-beta indices.
The forums in Melbourne, on Wednesday February 26, and Sydney, on Thursday February 27, were “at capacity” Marian Poirier said last week.
Paul Hennessy said the initiative was “not about pushing a particular product – it’s about helping the whole industry”.
– G.B.
