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.
Australia bucks global trend with active preference
The shift in investor preference for passive over active funds continued in the last two years, but Australian investors were more resistant to the global trend, according to research from Calastone.
Calastone’s latest report, ‘Tidal Forces – Can Active Funds Fight the Passive Flows?’ compiled from analysis of fund transactions across its network during the last two years, shows that the global policy response to the pandemic prompted significant net fund inflows as markets began to soar from April 2020 onwards.
Over the course of 2020, a net US$19.5 billion (A$28.2 billion) flowed across Calastone’s network into equity funds. More than half of this was in the last two months of the year.
Australian investors were also very bullish, adding US$4.7 billion to their equity fund holdings last year. Three-fifths of this was in November and December alone as vaccine approvals raised hopes for an end to the pandemic.
Index trackers are comfortably beating active funds in the race to attract new capital. Across Calastone’s global network, they garnered inflows of US$10.0 billion in 2019 and a further US$13.5 billion in 2020. Across every major territory and across every equity fund category, passive funds outpaced their active equivalents in the last two years.
Active funds saw net outflows of US$11.4 billion in 2019 and would have shed cash again in 2020 were it not for a dramatic turnaround in the final quarter. By the end of the year, investors added a net US$6.0 billion to their holdings – not enough to make up for 2019 outflows.
In Australia, the preference for passive funds has been less clearly ahead of active funds than elsewhere. Australians added modestly to their active fund holdings in 2019 and significantly in 2020, in contrast to the rest of the world.
Over the two-year period, these net inflows totalled A$5.7bn. Unlike investors elsewhere, Australians added less to index funds – net A$3.6bn. Even so, Calastone’s Fund Flow Index rated the passive flows higher because they took place on lower overall transaction volumes, indicating greater investor conviction. To this extent, Australia follows the global trend.
The one area where the active fund management industry is mounting a successful defence against the rise of index trackers is with ESG-related funds. They are the undisputed success story of the last two years for the asset management industry, the report says.
From a near standing start, ESG-orientated funds have captured investor imagination to such an extent that, for the last two years, they have taken $84 in every net $100 flowing over the network into equity funds of any kind, a total of $15.1 billion out of $18.1 billion. Net inflows rose seven-fold between 2019 and 2020, even though overall turnover in ESG funds only doubled.
UK and European investors have been the keenest buyers of ESG funds. Based on fund flows, Australian and Asian investors appear to be about two and three years behind the curve respectively, although appetite is growing. In 2019 and 2020, Australian investors added just A$1.2 billion to ESG equity funds, only $1 for every $13 that flowed into equity funds of any kind – a fraction of the global average.
Edward Glyn, head of global markets for Calastone, said: “The long bull market has favoured passive funds. Savers are quite happy to ride a rising index and take the simple market return.
“But passive investors are all-in on market bubbles and market crashes alike. Moreover, the rise of mega-caps like Apple and Amazon has increased absolute risk for passive investors, even if a fund continues to mirror the market perfectly. This is a sort of hidden risk.”
Glyn said: “In more challenging market times, many argue that active managers should be able to mitigate the risk of volatile markets and therefore generate outperformance. Investors generally have greater aversion to losses than they have appetite for gains so they should logically opt for active funds in times of trouble. There has not, however, been a sustained bear market for more than a decade, as even the convulsions caused by the onset of the pandemic were quickly sedated with enormous quantities of central bank liquidity and government cash.”
Ross Fox, managing director and Australia and New Zealand country head, said: “Australians are pretty patriotic when it comes to their investments. More than a third of the money they added to equity funds in 2020 went into funds that only invest in Australian equities. In Europe, the UK, and most of Asia, investors prefer to take a more global approach.
“In Australia, discourse in the financial services industry is more frequently turning to ESG. The topic is still more muted than in the UK and Europe and the home-market bias leaves investors with fewer assets that would meet global ESG standards. Across Asia, the speed at which attitudes are changing depends on the level of market development.”
Fox said Calastone’s new Fund Flow Index (FFI) would be launched in Australia later this year. It would provide detailed quarterly insight into Australian investor behaviour, tracking which fund categories are attracting most new capital or suffering outflows.
