Your Actively Managed Superannuation Fund Cannot Beat the Market

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While housing bulls gnash their teeth over that one, what about shares? They were down again Friday in New York. The Dow Jones Industrials fell another 2.7%. All those green shoots are getting eaten by the Black Swan of deleveraging.

Here is a more worrisome note, though: you can’t beat the market. Or at least, your actively managed superannuation fund cannot beat the market. That is the conclusion of two researchers from the Australian Prudential Regulation Authority (APRA). This is probably unwelcome news from those in the actively-managed superannuation funds business.

“On average,” researchers Wilson Sy and Kevin Liu conclude,” value adding from active management appears statistically to be unable to overcome higher costs associated with attempts to exploit market inefficiencies…Higher management expenses leads to poorer net investment performance of the firms.”

There are at least two points worth noting in this survey, three actually. First, actively managed funds, on average, don’t beat the market. Unless you know a genius manager, paying for results doesn’t deliver them. Second, the underperformance (by about 0.9%) is directly attributed to the fees you pay. If you invested in a passively-managed index tracking fund, you would do just as well as the market, and not pay a cent.

But the most incriminating finding from the study is that active managers do worse in a bear market! That shouldn’t be too surprising, really. Fund managers are paid to be in the market, not to be in cash. This is true even when you are better switching to a super option more heavily weighted in cash. Cash does not generation commissions!

To be fair, the study showed that half of the 115 superannuation funds beat the benchmark index (with the best fund doing 18% better). But the big question this study prompts is whether-by correctly making a few key decisions-a self-managed super investors can regularly do better than actively managed funds AND benchmark indices.

Beating most actively managed funds shouldn’t be hard, we’d humbly suggest. They outperformance the index anyway, when you figure in management fees. And because the funds show a bias to shares, (these funds allocate 50% of assets to Aussie and international shares), they are likely to get clobbered when asset allocation models suggest you ought to shift to cash, fixed income, or (ahem), property.

Of course the truth of the matter is that being in the right asset class at the right time is the single-biggest determinant to how well you do as an investor. That is, you don’t have to be Warren Buffet to beat the market. You just have to be in the right market at the right time. Stock selection, as much as it is touted by value investors, is simply less important than whether or not stocks as an asset class are rising.

You don’t have to be a highly paid fund manager to know whether stocks are in a primary bull market. In fact, the fund managers are likely to get it wrong because they would prefer stocks to be in a bull market. It makes the job of index tracking and fee collection much easier. But the real challenge is correctly interpreting those inflection points in the market where one asset class falls out of favour (peaks out) and another, previously ignored or cheap asset (kudos to the value crew) enters into a bull market.

Those are the tough spots to pick. But we wonder why a professional fund manager is any better equipped to call those market tipping points than a well-informed self-managed super investor who cares more about his money than generating fee income. In fact, a well-informed investor who accumulates a variety of different perspectives and then reconciles that information with his own preferences, risk appetite, and judgment is just as likely to get the big calls right as anyone else. Probably more likely, considering he doesn’t have any bias toward a particular asset class.

If you want to read the whole study, go here. For now, we’ll quote two important pieces of it that show that making basic decisions about how you allocate your assets is the single-biggest factor in determining the performance of your super fund.

“It is seen that 38.5% to 66.7% of the cross-sectional annual returns of our dataset are explained by their benchmark asset allocations, depending on the period and depending on whether the comparison is gross or net of costs. Over the whole five-period, the cancellation of short-term noise leads to an R-squared of more than 95%. Our results are consistent with expectations from earlier research (Brinson et al., 1986, 1991; Ibbotson and Kaplan, 2000).

You read that right. Your super returns are determined by being in the right place at the right time. This is the quiet little secret of great investment returns. Getting them may be hard. But it’s not impossible. But why is it true?

“These results have very simple explanations. It is clear that the greater are the differences in returns to different asset classes, the more asset allocation explains performance. Over the short-term, the asset return differences may be insignificant and may be swamped by other short-term effects of active management; asset return differences explain less of the cross-sectional variability. Asset allocation explains more of time variability because over time the differences in returns of different asset classes become more statistically significant.”

Over the short-term, property and fixed income may look safer and better than precious metals and cash. But if bonds are in long-term bear market, if we are in a Credit Depression, and if fiat money is entering a permanent period of decline, then getting your asset allocation right now has never been more important. Perhaps, according to the reader below, you should consider cattle.

–Hi folks – enjoy the DR. Current topic is moot … what is real wealth? Just one version of the answer – the age-old definition – comes from no other authority than the Bible:

“LANDS AND CATTLE”

No desire to get into religion in any form – please – but this is an interesting concept of what real wealth is, n’est ce pas?

Kind regards

Ivan B.

QLD

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Dan, sometimes you speak of things u know little about and articles like this are truly very frustrating. What a load of crap.

    I worked for a boutique fund manager in Sydney up until just recently. Our performance was excellent and well above the index returns over 1, 2, 3 and 4 year time frames. In fact our out-performance numbers over these same periods were 1yr +26.7%, 2yr +12.3%, 3yr +22.5%, 4yr +14.4%.

    We were stock pickers and ran a concentrated fund of less than 15 businesses based on teachings from whom u talk about – Warren Buffett. OUR superannuation clients did VERY well by allowing us to actively think and invest their capital rather than just hug an index.

    What your article suggests is that there is not point in thinking. Well, rather than being frustrated, perhaps I should congratulate you on an excellent piece. I guess I should actually be happy with this research… what could be better than to be in a business with other investors who feel that there is no point in actually thinking for themselves?

    Relying on a report produced by a lazy Government run organisation that gets paid not to think is highly questionable. Please research your own articles next time.

    Russell.
    July 7, 2009
    Reply
  2. Russell – I doubt that Dan or anyone else could reproduce that research, because they wouldn’t be given access to the data. It would be a good idea to read the report before bagging it. For example, it recognises that there are high-performing funds that consistently stay in the top quartile; unfortunately, though, there are more that consistently underperform, and underperformance seems to be stickier.

    The main point of the report (as opposed to the way it’s been reported) was to call for better information so that people could assess their options more knowledgeably. This seems to be a move towards more thinking, not less.

    Reply
  3. Hi Russell

    Care to add the name of said boutique fund manager? I am seriously looking at moving my money from my current fund manager to one who actually makes positive returns well above the average and benchmark.

    Putting all my super into an index fund would be even more agreeable than accepting my current fund manager’s ‘performance’

    Reply
  4. Dan, I find your work very interesting (I am a Financial Planner and was a Stockbroker for many years by the way) and I always enjoy a ‘contrarian’ whovever, the thing that frustrates the life out of me, is that all those who knock Modern Portfolio Theory make very valid point, but one thing they they (and you) fail to do, is present a viable alternative. I would be the first to admit that MPT is not perfect, but those who suggest that Tactical Asset Allocation (or simply timing) is a better option, provide no explanation of how this is to be achieved or no evidence that they are actually successful using it. There are plenty of Stockbrokers and others out there who claim to be good at timing, but where’s the hard evidence. Anyway, thanks for the article. Cheers Bob.

    Reply
  5. A viable alternative? How about a performance-based system, Bob? Using OPM, you lose… you don’t get paid.
    We knock realtors on this forum (sometimes for good reason!) but with the exception of auctions (those dupe shows…) if there’s no result, there’s _no_ payment… .

    Biker Pete
    July 8, 2009
    Reply
  6. Biker Pete, I am a Financial Planner, not an investment manager. I (like most Financial Planners) outsource the investment management function to investment managers. I am the co-pilot holding the map. Does your doctor work on a performance-based system? If you get cancer, does he only get paid if you go into remission? I am the advocate, trying to help my clients navigate through an uncertain investment landscape. I read in the paper the other day that retail investors have lost $8Billion (that’s eight thousand million dollars) in failed investment schemes. This is why I only invest in passive and low-cost index funds for clients. The big dilemma is do we follow Modern Portfolio Theory which says that you should stay invested (and diversified) at all times, or do we try to ‘time’ which investments to be in and when? Timing is very easy in hindsight, as it now seems that everyone saw the GFC coming, but in reality, it is extremely difficult. In fact in the USA Dalbar (a research firm) have studied the returns achieved by the average investor (in Mutual funds) over a 20 year period and found that while the market deliver 11.8%pa the average investor achieved 4.3%pa…why due to poor timing decisions (selling at the bottom and buying at the top). I still think the knockers of MPT need to put up or shut up.

    Bob Jobson
    July 9, 2009
    Reply
  7. The problem is that any systematic framework for investing is going to have flaws. Portfolio theory is a good theory, but (correct me if I am wrong) uses symmetrical risk curves.
    5 years ago or so, I read an interesting piece from a statistician working with finance. He pointed out that risk in markets is strongly assymetrical. That is that the chance of a catastrophic decline in price is higher than the equivalent gain in price.
    That blows apart investment theories which use symetrical risk models to make the calculations solvable.
    The Black Scholes formula for pricing options uses a symmetrical risk model.
    And then the notorious Gaussian copula formula. Similarly used for scenarios beyond its limitations. http://minitutorials.com/forums/index.php?showtopic=4609

    Reply
  8. Richo. I agree, though in saying. I’m not a financial planner but if I were, I’d be telling many of my clients to keep a substantial portion of their powder dry. Its like a battlefield out there and you need to be willing and able to either redeply your troops on a daily/hourly basis OR stay well in the rear. (This is where is where most Bob’s clients would, I guess, want to be.) If there is another market “correction” the Mums&Dads could wisely dabble into consumer stables like WOW for long term dividends but timing advice is also important here. You will currently pay a premium for getting into stocks that are “perceived” to be defensive.

    I don’t believe there is any obligation for me or anyone else to diversify onto battle fronts that are likely to be high loss makers in the short to medium term. That said, IF an asset class, say commercial or residential property tanks out completely there is may be tactical advantage in putting your entire portfolio there for a period of time. .

    My thinking is of course not foolproof and it has been a red ink week for my gold and energy speculatives. Interestingly, I have (so far) done no worse this week than my industry superfund which follows a diversified/passive/largely blue chip approach to equity investment. We’re both down about 4.5%. My downside may be similar to the industry fund BUT my upside potential is, I believe, much better.

    On the issue of timing I haven’t done too badly so far but I don’t have a crystal ball. Consequently I don’t tend to dive into (or out of) anything too quickly. I’m willing to pay higher transaction fees to nibble into a stock over time rather than punt it all in one go. Similarly, when the time comes for me to move super funds from cash into Aussie equities this may well occur in monthly chunks of 10 to 20 percent of portfolio value. This is not a foolproof strategy but it may mitigate some timing risks in some circumstances.

    Coffee Addict
    July 9, 2009
    Reply
  9. I think one problem we have is people think that just because something is a “system” that somehow this means it is faultless and will always work. It has been so long since we faced harsh economic times in Australia that people have simply forgotten that sometimes you have years of negative returns.

    My own view is that you should treat investing like a business. You do not run a business simply to get tax credits so likewise you should not invest in something simply because it looks tax effective.

    I am not really into “systems” as such, I prefer to simply invest in areas where I see long term potential but I see the merit in having a balanced portfolio..it is a hedge against errors.

    Bashing financial planners can go too far and few self appointed investment legends ever disclose in any detail what they hold in their portfolios or how they trade. (I am not an F.P by the way) We have good investment years and we have shockers…that is simply the way things go and that isn’t the financial planners fault.

    Reply
  10. Brian,

    Feel free to send me a quick email. rcmuldoon@live.com I can point u in the right direction of the team responsible for this performance. FYI, it is also a publicly listed business with a Top Teir audit firm, so accuracy and integrity is assured.

    Russell

    Reply

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