Managed Funds

You will often hear me talk about the poor performance as a whole of the managed fund industry, after taking into account fees. Mathematically of course, over any given period, 50% of funds are going to out-perform and 50% will under-perform. Unfortunately, studies have shown that when fees and charges are added into that, over 80% of all managed funds fail to beat a basic benchmark.

I decided, rather than trust someone else’s ‘studies’; I would look into the matter myself. Here was what I discovered:

Comsec (EGP’s discount broker of choice) has a universe of managed funds for its clients to use. There are 560 in total; I downloaded all of these, including their MER (Management Expense Ratio) and their performance over 1, 3 & 5 years into a spreadsheet so that I could get the data into a workable form.

As an Australian investor, there is really only 2 sets of indices I think serve as a valid performance comparison of market performance, the S&P/ASX200 (TR) and the All Ordinaries Accumulation Index. These measure the majority of the Australian market by market capitalisation on a dividend reinvested basis. As at 12/11/2010, the 1, 3 & 5 year returns of the S&P/ASX200 (TR) were 4.58%, -7.57% & 5.35%. Bearing in mind that the bear market of 2007/2008 commenced 3 years 16 days ago (makes the 3 year figures look dreadful). These are the benchmarks I will use to evaluate the funds.

Of the 560 funds, only 354 have a 5 year or greater track record. Of this 354, there are only 37, or 10.45% that beat the benchmark. This of course means 89.55% of all funds managed in Australia over the last 5 years would have returned a better result by investing their funds directly in the ASX200.

There are 536 funds that have been running for over 1 year. 148 of these or 27.61% have equalled or beaten the benchmark, proving only that it’s easier to beat the market in a single year than to do so on a sustained basis.

This brings me to my next point which is what might be termed ‘elimination bias’, whereby the worst performing funds are either closed, or wrapped into other products, so the manager can present a more successful ‘history’ in their PDS. This makes the 10.45% who beat the market over 5 years an even smaller figure because many of the other funds that make up the universe disappear through poor performance leading to unmarketability. Assume the universe should consist of 450 funds rather than the 354 remaining due to elimination bias (this is an assumed number as the true number removed is unknowable). Under this assumed circumstance, there are more like 8.22% out-performers.

The average MER for the 354 products with a 5 year history is 1.95%. The average MER of the 37 products which beat the benchmark was 1.80%. The 37 worst performing products had an MER of 2.02% (on average, if you’d have invested $100,000 in these funds 5 years ago, you’d now have the princely sum of $63,717 of capital remaining). This disproves, at least when it comes to fund management, the idea that you get what you pay for.

Similar results are found in the 1 year charts, the best performers charge below average fees and the worst performers charge the highest fees. When you look through the PDS of the higher performing products, invariably you discover a very low ‘annual charge’ and a higher ‘performance fee’ compared to the lower performers, which inevitably have higher annual fees and smaller performance fees.

The issue here is ‘alignment’. The more strongly the fund-managers interests are aligned with the unit-holders interests, generally the better the performance.

Some who look at this universe will state - but many of these are ‘world’ or ‘global’ products, the S&P/ASX200 (TR) is not a valid benchmark. To those people, I took the trouble of stripping out ‘global’, ‘world’, ‘commodities’, ‘gold’, ‘bond’ & ‘property’ products and was left with a universe of 232 Australian ‘equities’ facing products with a 5 year performance history. Care to predict the results?

26 out of the 232 products, 11.21% beat the indices. The out-performers charged below average fees. 4 out of 232 (1.72%) beat the index by more than 3% per annum over 5 years, and a single solitary 1 (0.43%) beat the benchmark by more than 5% per annum over the last 5 years.

There were 334 Australian ‘equities’ products with a 1 year performance history 86 of these, or 25.75%, out-performed the benchmark.

The conclusion – on an annualised basis, about ¼ of all fund managers will beat the index after fees are deducted, and generally less than 12% of fund managers will maintain index out-performance over a 5 year period, probably more like 7 or 8% when ‘elimination bias’ is factored in.

The solution - invest the proportion of your wealth you want exposed to equities one of two ways (or a combination of both) in either:

a) buy a low cost and liquid index fund such as SPDR 200 FUND ETF UNITS (trading on the ASX with ticker code STW), which after fees & costs has a tracking error over 5 years of less than 3% (about 0.5% per annum); or

b) find yourself a fund manager, who will charge you no fees, excepting in the event that a predetermined benchmark is beaten and who will have substantially all of their net worth exposed to the same investments as yours. Off the top of my head, I can think of EGP Fund No. 1 – Tony Hansen 17/11/10. (p.s. If you wish to see the list, e-mail us – eternalgrowthpartners@gmail.com and I will send it to you)