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Posted on 13 Oct 2016 by Steve Johnson
Setting Daniel’s closet index huggers to one side, the past few years have been exceptional for Australia’s genuinely active fund managers. Our Australian Shares Fund has returned 34% over the last 12 months. According to Morningstar, that ranked the Fund just 7th out of 24 in its category. There are plenty of fund managers that have returned better than 30% this last year. And that’s one in which the main index, the All Ordinaries Index, returned just 14% including dividends.
When it comes to international shares, the opposite has been true. Our International Shares Fund has outperformed the index by just 4.8% over the past year, yet that ranks it 10th out of 204 global funds Morningstar deems to be similar. Over three years, we are less than 1% ahead, yet Morningstar ranks the three-year performance 11th out of 176 funds.
One conclusion could be that we have some of the best and brightest fund managers in the world. If that is the case, though, there should be plenty of Australian based international funds shooting the lights out too.
Another conclusion could be that we should all stick to our own back yards. Perhaps the returns are simply better in our own home market. If that were true, though, we should see New York and London based fund managers performing just as well in their home markets. If those exist at the moment, they are particularly difficult to find. The international press is awash with commentary about how disastrous active management has been over the past few years.
So how do we explain the vast gulf between Aussie fund managers and their global peers?
Index not the manager
Well, it might pay to look at the indexes rather than the fund managers. Most stock market indexes weight each of their constituents by market capitalisation. Telstra has a market capitalisation ten times that of TPG Telecom, so it gets 10 times TPG’s weight in the index.
So the performance of large companies matters a lot more than the performance of small ones. In Australia, the share prices of our largest companies – the four big banks, Telstra, BHP Billiton and Rio Tinto make up 36% of the index – have performed poorly over the past year. In the U.S. the opposite has been true. Facebook, Amazon, Netflix and Google have lifted what would have otherwise been a muted index.
You can see the difference by comparing the indexes weighted by market capitalisation with ones where all stocks are given an equal weighting. The All Ords has underperformed an equal weighted index by a whopping 9%, while the American index has outperformed its equivalent by 2%.
Aside from requiring enough liquidity to be able to invest in the stock, most genuinely active fund managers couldn’t give a hoot about market capitalisation. If TPG offers better returns than Telstra, we will buy TPG and not Telstra. So the fact that large caps have dramatically underperformed has been a huge tailwind in Australia. Internationally, their outperformance has been a headwind.
None of this should be particularly relevant over the long term. The variation in performance is hardly ever this wide and will likely mean-revert over time. But for the moment you should treat Aussie fund manager boasting – including ours – with a degree of scepticism. The tail wind has been gale-force.
Past performance is no guarantee of future performance. In fact, there is often a negative correlation between the two.
Great job Steve!
PS: Check out OFX for suspicious trading – reporting period ended 30 Sept so it looks like someone knows something (not retail investors) yet ASX/ASIC are again silent.
It’ll be interesting to watch OFX from the sidelines. I had a small (50bps) holding, that I sold this morning for a very small loss after I couldn’t shake this uneasy feeling about it.
Normally, I buy as prices fall, and I normally never take any cues from price movements, but in chess they say that the difference between a master and an expert is that an expert knows every principle, and a master knows when to break them.
I think that is a smart move – some big money seems to “know” with almost certainty that the upcoming results for the half ending 30 Sept. are going to be terrible. I have seen more credible trading in fixed tennis matches when the odds keeping dropping on the player who is down 0-2 sets and ends up winning as the market predicted.
As I have made my point this will be my last post on how the Australian stock market is absolutely disgusting with the amount of insider trading (eg RNY, Newcrest mining, etc etc etc etc etc) that is left unchecked by ASX/ASIC. However probably best just to accept it and make some money. Today’s example is Qantas who is reporting quarterly figures on Monday (31/10/26). Trading this morning (AORD up 0.1%, Air NZ up 0.3%, Virgin up 3.0%, QANTAS down 3.0% big volume) certainly indicates that this report is going to be much worse than expected. With the publicly available information I would be tempted to buy some here however I would definitely only go short here knowing how the ASX market operates.
Boom! Qantas down ~6% at the open. I wonder if it would be legal for someone to open an ASX implied insider trading fund? Won’t hold my breath for ASIC (AKA resume padding lawyers looking for a high paying job at investment banks) to do something. Maybe they should look at hiring some quantitatively skilled people although they have much better options (Google, Facebook, hedge funds) than some hopeless bureaucracy.
Hi Frank, I highly value the opinions of value investors with a nonconformist paradigm. I’d be interested in connecting with you and if you are in Melbourne, catching up for a coffee. My hotcopper handle is ‘shumsta’ and I check my threads there a few times per week. Or you can email me at shumsta at Yahoo dot com.
Great call once again Frank! I’m glad that I followed my instincts and got out of OFX before the well telegraphed bad news came out today.
OFX, QAN and BLX make it three out of three at my last count.
Feel free to get in touch with me. I’d be happy to make it worth your while.
There are a million ways of dissecting performance. In any given year there will always be aspects of asset allocation that will give one group of money managers a huge edge over the others. This time it is a market cap divergence, next time it’ll be something else.
I’m also of the opinion that, in any given year, luck is the overwhelming determinant of every investor’s performance. True skill only becomes apparent when measured across the entire length of at least one complete business/market cycle.
It’s a valid point, the core of my funds are in index ETF’s. For global I’m happy to hold the low cost, traditional market cap ETF’s. For Australia I became concerned about the index a year ago and have been switching into MVW (equal weighted index) as well as some LIC’s, and recently joined FASF. IMHO, a lot of the index theory by Bogle and others was developed with the US in mind and there are some issues translating it directly to Australia.
Anyway I guess not too many index investors are around here, so the main point is what is a valid benchmark. The ASX200/300 has high sector/market cap concentration. The small ords has lots of duds and has been easily outperformed by active funds over the long-term, although it has been a bit tougher in the recent past. No obvious answer but perhaps equal weight is the least worst option I can see.