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The balanced manager : A dinosaur?

Balanced funds fall to add value according to Mercer Investment Consulting.

Monday, April 6th 1998, 12:00AM

by Philip Macalister

The Mercer Survey includes the returns achieved by managers for balanced superannuation schemes. That survey, however, does not attempt to break down the extent to which differences in returns between managers are affected by different benchmark mixes as opposed to active management.

Mercer Investment Consulting has completed a number of investment research papers which now form the core views of our advice to clients. One of these papers explores the issues surrounding balanced versus specialist management of asset portfolios within the New Zealand market.

The following table summarises our analysis of the value added by balanced managers over the three years to December 1997. The analysis measures managers’ performance relative to benchmark mixes that they have adopted for the balanced fund we are analysing.

Total Amount of Value Added

Number of Managers

Above 2% pa

1% pa to 2% pa

0.5% pa to 1% pa

0% pa to 0.5% pa

-1% pa to 0% pa

Below -1% pa

1

0

1

4

1

5

That is, only two managers added more than 0.5% per annum through their active management over the three years to December 1997. This suggests that few balanced managers will be achieving their clients’ performance objectives.

Most balanced managers fulfil the role of an active asset allocator. Our analysis suggests that not many managers are successfully fulfilling that role. The following table summarises our analysis of the value added by active asset allocation over this three year period.

Total Amount of Active Asset Allocation

Value Added

Number of Managers

Above 0.5% pa

0% pa to 0.5% pa

-0.5% pa to 0% pa

-1% pa to -0.5% pa

Below -1% pa

1

3

3

4

1

That is, most managers are subtracting value through their active asset allocation activities.

We would point out that the analysis overstates the value added by active asset allocation in the sense that the transaction costs (that can be significant) tend to be absorbed within the sector returns. It should be noted that our analysis does not include value which was added or lost from currency management or country selection within the overseas shares or fixed interest sectors - such value added/lost will be regarded as being stock selection. While we would regard these activities as being more active asset allocation in their nature, the information provided by most local managers is inadequate for them to be analysed as such.

Does this analysis contradict the often-made statement that "asset allocation decisions dominate investment returns for balanced portfolios"?

No, it does not. This statement applies to the policy asset allocation. In other words, the process of establishing the benchmark mix. Our analysis indicates that the benchmark mix has explained at least 85% of the returns achieved by managers participating in the Mercer Survey of balanced suerannuation funds over the three-year period.

The above observations support our view that investing via a properly managed sector specialist structure substantially improves the odds of achieving superior performance over the balanced alternative. We are also of the view that active asset allocation should either be passive (i.e. no active changes relative to the benchmark portfolio) or should be achieved via specialist TAA structures, none of which currently exist in New Zealand. With the ability to utilise pooled funds, a sector specialist structure is an option for most wholesale investors.

This article appeared in Mercer Investment Consulting's April Communique newsletter.

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