Heavyweights duke out investment strategies

Two heavyweights of the New Zealand financial industry have gone head to head in a debate at the IFA conference over whether investing direct or via managed funds is the better option.

Wednesday, July 18th 2012, 8:10AM 4 Comments

by Niko Kloeten

In the direct investment corner was Mark Lister, head of private wealth research at Craigs Investment Partners; representing managed funds was Milford Asset Management’s Brian Gaynor.

Lister said some of the benefits of investing directly included transparency, liquidity, income generation and low fees, as well as the ability to tailor a portfolio to your exact needs.

“Knowing what they own is really crucial,” he said. “People don’t like to see a black box type fund that owns a bunch of things; they want to know what shares and companies they own and what markets they are in.”

He also said fund managers tend to underperform the market on average, referencing a study reported in The Economist that found that between 1980 and 2005 the US stock market returned 12.3% per year but the average managed US share fund only returned 10.0%.

Lister used the example of Warren Buffet to show how fund management fees can eat into returns.

An investment of $1000 in Berkshire Hathaway in 1965 would be worth $5.1 million today, he said; however, if Buffet charged like some fund managers do (1.5% base fee with a 20% performance fee above an 8% hurdle) that amount would have been reduced to $1.1 million.

However, Gaynor said the introduction of the PIE (Portfolio Investment Entity) regime in 2007 had significantly changed the equation in the New Zealand context in favour of managed funds.

He used his company as an example, saying that in June 2007 pre-PIE the investment team managed none of Milford’s funds under management while advisers managed 100%; now the investment team manages 81% and the advisers only 19%.

“Managed funds have more legal protection; they are subject to the prospectus regime whereas direct funds are not,” Gaynor said.

He mentioned the debacle over Hubbard Management Funds, which has resulted in a court battle over distribution of investor funds, as an example of what can go wrong in a legal sense with the direct approach.

He said managed funds offered some advantages in terms of investment management: “Direct funds only have a buy and hold strategy whereas managed funds can take advantage of market volatility.”

Another benefit of managed funds, he said, is the exposure investors can get to small-cap companies not researched by the big broking firms.

Niko Kloeten can be contacted at niko@goodreturns.co.nz

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Comments from our readers

On 18 July 2012 at 9:53 am Anonymous said:

I wonder if NZ lacks the skills or are we too laid back for our infatuation with managed funds. Most definitely its the latter. It's so easy to depend on the abilities of the fund managers that we are just missing out on all that going direct has to offer. Are we so naive or is the NZ market too big that we cannot evaluate which are the good companies to invest into. We definitely lack the turnovers and the use of derivatives which could offer hedging strategies. But with managed funds, as rightly pointed out by Mark, fees simply erode the gains. And it's just not the fund manager you are paying but your adviser as well who would, to the best of his knowledge, recommend funds he believes would perform. But how well does an adviser know of the abilities of a fund manager, for which he has to rely on third party ratings. How well does an adviser know of the strategies the fund manager would employ to generate returns and whether they would be right? And what when there is a sudden exit of a manager who's joined some other company - the fund takes a nosedive. And the angry investor who sees the fees he has paid to get the negative returns blames his adviser who didn't have the slightest clue what the fund manager was up to.

Responsibility and accountability should go hand in hand but that's not the case here. I'm not questioning the abilities of fund managers who are literary people and put in a lot of research behind their funds for generating 'alpha', the holy grail of investments, and they definitely deserve to be paid for their efforts. But from an investors perspective he is not getting paid even though the fund is able to generate the alpha which in recent times has meant a lesser negative return compared to the benchmark, but nevertheless negative. Maybe it's just me but I haven't come across a single fund manager who has given consistent positive returns year on year, I'm not talking the long term which is the fund manager's excuse, because till the time investor waits to see a positive return over the long term, the fees would have eroded 75% of it. Or the exceptional run in bonds we have had for last 5 years or so where any fixed interest fund would have yielded good returns.

And if you were to go long term do you think you could go wrong investing in Apple or Google or Microsoft?

On 18 July 2012 at 8:56 pm Independent Observer said:

Anonymous presents an interesting series of views:

I agree that investing in domestic equities is most likely an event that most investors are capable of doing direct – particularly if they are staying with reputable brands, and not looking to actively trade.

I don’t have the same confidence with domestic bonds, with most investors (and financial advisers) simply unaware of the impacts of duration, yield spreads – and most importantly – credit. Fixed interest management is more about preservation of capital, than delivering startling returns… something that is difficult to do as a part-time enthusiast.

Where funds managers seem to come into their own, is when they deliver an offering or a capability that is difficult to replicate through direct investment. These typically seem to be with offshore exposures, and are often areas where managers have specific (and proven) areas of expertise. It is worth reflecting on the nifty fifty stocks that dominated the 1960s & 1970s, when suggesting that a buy & hold strategy of today’s leading brands can do no wrong.

Bottom line: you get what you pay for… with investors who are looking to cut costs bound to receive commensurate returns.

On 19 July 2012 at 10:23 am Alan said:

Liquidity risk in the domestic market cannot be ignored when dealing with direct investment. The inability to open and close positions can have a significant impact the client's overall returns, even with some of NZX50 companies. Managed funds allow the client to liquidate their position quickly, if required.

On 19 July 2012 at 11:43 am Dean said:

I do not use an adviser to select my fund managers but I do use managed funds, for both balanced and single-asset-class portfolios. That's because I have more faith in my manager selection and asset class allocation capabilities than in my security selection abilities. I haven't analysed whether my fund performance has outweighed the extra cost compared to direct investment, but I do sleep better at night and I have more time to do other things. And I agree with Independent Observer regarding offshore investment; no way I could do it directly and diversify properly.

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