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Some active managers delivering little for fee: Report

Some New Zealand active equity managers are running investments only 27% different from the index, a new report has found.

Friday, August 11th 2017, 6:00AM 7 Comments

by Susan Edmunds

Actuaries MJW have released a new report on active share.

Principal Ben Trollip said clients would not be averse to paying managers more fees if they could achieve a better result than the index.

"But what does it mean to be active? If I were to hold 48 of the 50 stocks in the S&P/NZX50 index and just slightly overweight Xero and underweight Trade Me, would you be happy paying me a large fee? With over 90% of my portfolio simply replicating the index, perhaps you'd argue I'm due at most a tenth of a full active management fee. After all, most of my portfolio would generate the index return, making it unlikely that the overall result would differ too much from the benchmark."

He said the measurement of active share was one way to determine how much an active manager was exercising their convictions.

Active share is calculated by adding the difference in allocation for each stock, between the portfolio and the benchmark index.

An active share of 0% would be a portfolio that was completely the same as the index and 100% would be completely different.

MJW research showed that of six active equity managers in New Zealand, none had more than 53% active share. Two only had 27%.

Trollip said that was a surprise “I knew the numbers were going to be low but that was a lot lower than expected. And they all call themselves active managers. Seeing below 30% was very surprising.”

He said that could be a concern to investors: “It is crucial that investors are getting what they pay for when employing an active fund manager. If your portfolio is only 30% different from the index, should you really be paying the same fee as a portfolio that is 60%, 70% or 80% active?”

He said fees “still had room to come down a bit more. If you look at the value-add they are generating and the fee they are charging. What is a fair proportion of value-add that the manager should be taking?”

New Zealand managers had a harder task to differentiate from the index than they would in a less concentrated market.

The maximum possible active share in New Zealand was only 64%, he said, assuming fairly tight stock limits (±2% versus index).

Tags: equities MJW

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Comments from our readers

On 11 August 2017 at 9:47 am thombentley said:
Active share is a useful addition to the assessment of whether a fund is truly active or not, but I'm not sure looking at NZ equity funds is all that helpful given the idiosyncrasies of our local market (limited number of stocks, high concentration of market cap in the top 10 names, very low liquidity below the top 10 or 15 names).

It would be good for MJW to carry out the same research on global equity funds run out of NZ/Australia to see how they stack up on active share.

However I agree with the point that active managers shouldn't be charging active fees unless they can demonstrate added value through outperformance of the benchmark and better risk adjusted returns than the benchmark.

A broader question is: how did we get to the point where so much active money is run on a 'closet index' basis?

In my experience, the global evolution of active fund management into the 'low tracking error, outperform the index by 2% p.a. before fees, target an information ratio of 0.5, hold minimal cash' type mandate has been driven by asset consultants, not fund managers.

Since the GFC I've seen a lot more retail fund launches targeting absolute returns, with concentrated portfolios (i.e. high active share) and high flexibility around cash weightings and other forms of downside protection. All of these characteristics are much more in line with what retail investors want, which is a better net of fee return than they can get from the bank or investment property.

On 11 August 2017 at 9:56 am Pragmatic said:
Great findings from MJW - with most industry participants completely unaware of the concept of active share, or whether their Managers actually add value.
On 11 August 2017 at 10:05 am thombentley said:
Active share is a useful addition to the assessment of whether a fund is truly active or not, but I'm not sure looking at NZ equity funds is all that helpful given the idiosyncrasies of our local market (limited number of stocks, high concentration of market cap in the top 10 names, very low liquidity below the top 10 or 15 names).

It would be good for MJW to carry out the same research on global equity funds run out of NZ/Australia to see how they stack up on active share.

However I agree with the point that active managers shouldn't be charging active fees unless they can demonstrate added value through outperformance of the benchmark and better risk adjusted returns than the benchmark.

A broader question is: how did we get to the point where so much active money is run on a 'closet index' basis?

In my experience, the global evolution of active fund management into the 'low tracking error, outperform the index by 2% p.a. before fees, target an information ratio of 0.5, hold minimal cash' type mandate has been driven by asset consultants, not fund managers.

Since the GFC I've seen a lot more retail fund launches targeting absolute returns, with concentrated portfolios (i.e. high active share) and high flexibility around cash weightings and other forms of downside protection. All of these characteristics are much more in line with what retail investors want, which is a better net of fee return than they can get from the bank or investment property.

On 11 August 2017 at 3:43 pm MPT Heretic said:
Actually the paper appears to offer mixed conclusions. It also states that over the last 4 years active managers have added value... presumably above benchmark and net of fees? And that Active Share is a point in time reference so may be a poor measure of how a manager trades over time and is not particularly applicable in the concentrated NZ market context. Not quite the sexy headline I guess
On 14 August 2017 at 7:58 am Brent Sheather said:
Hi Thom

Yes it would be interesting to see the performance of global equity funds run out of NZ. If you look at the top ten stocks in many actively managed NZ equity funds you will see that Vanguard and iShares ETFs feature prominently. This takes closet indexing to a new level and you would have to admit it is a great business model: get your silly client to pay for all your fund management costs (by investing through an index fund), charge your standard management fee and throw in a performance fee relative to a fixed interest benchmark. Probably the closest thing there is to turning water into wine. The obvious question is given that the UK and European regulators are getting stuck into closet indexing over there, where is the FMA? Probably the best approach to getting some action here is to embarrass the regulator into doing something although I would have to say it hasn’t worked so well thus far.
On 14 August 2017 at 10:29 am R1 said:
And it hasn't worked so far because the regulator's master has no interest in ensuring they police the regulations and live up to their charter. Time for a change of Government.
On 15 August 2017 at 4:11 pm Longitude68 said:
Adding to Thom's comments..... for a active managers in such a small, thinly traded market in a climate of advisers, trustees and others indoctrinated by researchers and consultants (riding a abnormal bull market),to focus on index benchmarks as the primary judgement of success or failure, then its no wonder the numbers stack up the way they do.

To move away from that is very brave indeed for them and commercially foolish in all probability (although I admit I detest benchmark huggers as much as I do passive funds). Give me three things;
1. Returns AND Risk taken over the risk free return, AND over a FULL cycle (ignore indices)
2. Advisers to publicly publish their portfolio results the same way.
3. Asset Consultants to publish their turnover of managers (with dates) compared to the relative recent historical performances (could the correlation be high here?).
Enough stirring perhaps!

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