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Posted on 05 May 2017 by Steve Johnson

Active Fundies Harming Their Cause

The tide has turned. When I wrote Fuzzy Future for Fundies almost a year ago, the concentrated nature of the ASX All Ordinaries Index was the only thing holding back the index investing wave.

So far Australia’s highly paid fund managers have escaped relatively unscathed. This could be because interest rates have been relatively high here, property prices have kept rising and attractive, low cost product is not yet as available here as it is overseas. The past 12 months have highlighted how useless the All Ordinaries Index is as a low risk way to access the sharemarket. Its absurdly high weighting to banks and resources companies meant that it underperformed an equal weighted index by some 7 per cent during the past financial year.

Since October last year, however, banks and resources companies have dramatically outperformed the rest of the market. Most active managers are underperforming the index. And that’s the window the ETF providers were looking for. After a year of puff pieces about outperforming fund managers, the Financial Review is full of articles on the benefits of low-cost passive funds.

Any active fund manager who thinks this trend is going to miraculously disappear is kidding themselves. I discussed the issue with James Daggar-Nickson on Sky Business yesterday.

Active Fundies Harming Their Cause
Active Fundies Harming Their Cause  Active Fundies Harming Their Cause  Active Fundies Harming Their Cause  Active Fundies Harming Their Cause

19 thoughts on “Active Fundies Harming Their Cause

    • Nonsensical argument from Joye. Choose the two most successful fund managers of all time (one of which is not accessible, and the other you need to pay a premium for) and use them to justify the thousands of funds that fail to deliver any value. What chance is the average investor of picking the one that outperforms?

  1. Thanks Steve and Forager, you are definitely ‘nuts’, and if you keep finding morsels for your clients to ‘squirrel away’ then we can all be ‘happy vegemites’.

  2. Hi Steve, another really great article.

    I invest in Forager because of the long-term nature of your (and my) investment horizon.

    This question is a bit off topic, but related to that horizon. What is the driver for Forager to issue dividends? I have always bemused that when a company issues a dividend, the unit price of the security usually falls by, or very close to, the unit price of the dividend. I have received cash, but the holding value remains fundamentally the same. What benefit is that to me? To the company?

    Why issue dividends? If people need cash, can’t they sell a small chunk of their shares at a time of their choosing?

    I would love to see a blog article on this.

    Keep up the brilliant work!

    • Hi Monika and thanks.
      Both of our funds are trusts, not companies, so you are receiving distributions and not dividends. A trust has no choice but to distribute all of its income every year to the unitholders. It’s not a choice we make – if we realise profits then we have to distribute the income to you. In the International Fund, we chose to distribute some of the income early this year. We would have had to do it at the end of the financial year anyway, but this way new investors aren’t slugged with the full tax bill at 30 June. Feel free to give us a call in the office if you want to understand this better.

      • Hi Steve, does the trust structure mean that once you realise a gain or receive a dividend it needs to sit in liquid assets (cash) until it is passed on to investors? Based on this would it not be worth making more frequent distributions to investors (eg quarterly) and assuming that a high proportion reinvest distributions, this would give this back to the fund to invest if opportunities are available?

        Given the Australian fund is now close ended, this would be even more important as there’s not a stream of new money coming in providing liquidity for new investment opportunities.

        • Hi Steve,

          We obviously need to make sure we have enough cash to pay the distribution in July but it doesn’t need to sit there and wait. We have historically had high reinvestment rates (roughly 70%). So even if we paid a 10% distribution, it would only be a 3% cash drain on the fund – perfectly manageable in the grand scheme of everyday liquidity.

          There is nothing stopping us making interim distributions (we made a special out of the International Fund this year). We just don’t want to make a distribution in the first half of the year and then realise that we didn’t need to make it because of losses in the second half that we could have used to offset the gains. Annual is the simplest, as long as the liquidity issues are manageable.

  3. thanks for speaking candidly, unlike Platinum’s recent defensive comments, it is refreshing and I think demonstrates Forager is confident it has a strategy to survive, unlike most of the others!!

    I’m not sure even the style of active you described will be that sustainable, i.e. low cost active that just provides a better diversified / lower risk portfolio. There are already ETF’s out there like MVW and EX20 that can be used to achieve the same for 0.35% or less fees. Correcting the index concentration issue can be done mechanically will still come down to whether those managers are adding value over these alternative ETF’s or not.

  4. Agree with you on fuzzy future for fundies. Curious on your thoughts about future fund of australia suggesting value managers could be replaced by computer programs?

    “This is because institutions such as the Future Fund can now use tools that assess an active stock picker not just against the benchmark, but against factors that are easily and cheaply replicable.

    For instance a ‘value’ manager that tries to find cheap stocks may be able to beat the market, but the performance may only lag or match that of an index that systematically buys stocks that appear cheap based on a measure, and sells expensive stocks.”

    • Hi Sean, good question. I’ve been thinking a lot about that and have no doubt the computers are going to get better and better. At the moment they are playing a different game – making money by trading days, minutes or microseconds. But if AI turns itself on long term returns I’m sure they can play the low PE/low price-NTA game as good as a human.
      It remains to be seen whether a computer can ever think abstractly though. Can an algorithm ever know that Lottoland coming into Australia is really good news for Jumbo Interactive? The numbers suggest high PE, high price to book but I thought it was screamingly cheap, and that an alternate business model was a plus when you only have one supplier.
      Who knows though? The pace of improvement is scary. If I’m out of a job in 5 years’ time I’ll hopefully take it gracefully.

  5. I don’t remember Steve being so vocal about “active vs passive” when his fund was massively underperforming the index in its early years!

  6. Love the video and performance over time, but can Steve elaborate on why the comparative benchmark for the Australian Fund being the All Ord Accum Index, is appropriate when one compares the actual stocks held in the fund? Basically is your comparative bench appropriate and why or why not?

    • Hi Stuart,

      I don’t think there is an index which is representative of our universe, which is one of the reasons we have a fixed 8% hurdle for performance fees rather than a benchmark.
      Perhaps a small cap index would be better at the moment (this would only make the performance look better). But there have been times where we have owned a significant number of larger stocks, and then small caps would be inappropriate.
      So we picked the broadest index we could and constantly try and be transparent when that has been a tailwind (FY2016) versus a headwind. Last year’s performance report does a pretty good job of that, and we will do the same again this year. We also encourage clients to focus on returns over the long term. The index is there to put those returns into context, but it is certainly not a valid comparison.

  7. Thanks Steve. That was an informative interview. The choice between active and passive investing was certainly at the forefront on my mind several years before I invested in Forager.

    I enjoyed the irony in seeing Warren Buffett, as an active fund manager, recently winning a bet with a hedge fund manager with regards to this very issue:

    Good to hear that keeping fees competitive is at the forefront of your minds. This is definitely one of the reasons why I decided to invest in this fund.

    P.S. Is there an economic motivation for the beard? I wonder…

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