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Better active managers look good

New Zealand Guardian Trust equity manager Ian Arkle asks whether actively managed New Zealand share funds can outperform their passive counterparts?

Monday, August 17th 1998, 12:00AM

by Philip Macalister

Passive New Zealand share funds are those funds which provide consistent representative exposure to the asset class benchmark, usually the NZSE 40 Gross share Index. These funds typically hold all or nearly all the stocks in the index in the correct ratios and, provided they have a tax clearance, pay no tax on net capital gains realised. They, therefore, provide close to index performance regularly.

Active funds, in contrast, attempt to add value over and above the returns produced by the NZSE 40 Gross Index by using investment management skills to "pick winners and avoid losers". These funds typically buy and sell their stocks more frequently and pay tax on net capital gains realised.

The Stock Exchange's TeNZ fund was the first passive fund launched in New Zealand. Since its arrival in 1996 many other funds with tax immunity have been developed based on other indices.

In the last 18 months, how have active and passive funds performed? The table below summarises three passive indices and actual active results from the William M. Mercer Survey of wholesale investment managers.

Quarterly


Returns

Passive

Active


William M. Mercer Survey

Quarter
(1)
Gross
10
Index
(2)
Gross
30
Index
(3)
Gross
40
Index

(4)
Upper
Quartile
Manager

(5)

Median
Manager

(6)
Lower
Quartile
Manager

30.06.98

-13.9

-11.8

-12.9

-8.9

-11.3

-12.5

31.03.98

1.9

1.3

0.7

2.3

1.2

0.5

31.12.97

-7.2

-8.4

-7.4

-7.0

-7.7

-8.4

30.09.97

3.1

2.7

3.2

4.4

39

3.1

30.06.97

15.9

13.2

13.4

14.3

13.4

11.6

31.03.97

-3.8

-2.9

-3.7

-3.5

-3.9

-4.2

31.12.96

8.8

9.6

10.1

12.9

12.0

11.7

All of the results are "gross", i.e. before any tax. Let us assume that the New Zealand sharemarket produces a long-term average total return before tax of say, 15 per cent annually. (NZGT has reconstructed the NZSE40 Index back to 1956 and, over this time, the average compound rate of total return was, in fact, 15.6 per cent annually).

Let us further assume that the first 6 per of gross return represents the (tax-free) dividend return. This leaves, on average, 9 per cent of capital return to be taxed at 33 per cent. Thus, in a very approximate sense, the active manager needs to outperform the passive manager by about 3 per cent a year to neutralise the taxation advantage of being passive.

This test may be a little severe on the active managers who, typically, would not turn over their portfolios once per year (to incur the cash liability for tax). Also, the index managers generally under-perform their respective indices through mis-matches and tracking errors. However, we can focus on columns (3) and (4) above to guage the actual results-to-date. i.e.

 

(3)

Gross 40 Index

(%)

(4)

Best Active Managers

(%)

(4) - (3)

Outperformance

(%)

Annualised

Outperformance

(%)

Q2 98

-12.9

-8.9

+4.0

-

Q1 98

0.7

2.3

+1.6

-

Q4 97

-7.4

-7.0

+0.4

-

Q3 97

3.2

4.4

+1.2

+7.2

Q2 97

13.4

14.3

+0.9

+4.1

Q1 97

-3.7

-3.5

+0.2

+2.7

Q4 96

10.1

12.9

+2.8

+5.1

 

The better active managers over the last year and half have proved their worth. In fact, their relative performance against benchmark has been very good indeed, even adjusting for the 3 per cent tax hurdle.

The question is can they keep this up for the next 10 years to justify their fees and investment approach? After the first year and one-half, it is clear that they are running comfortably ahead of the pace.

Ian V Arkle is New Zealand Guardian Trust's New Zealand Equities Manager

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