The debate about whether to select an active fund manager, or a passive manager through an index tracking exchange-traded fund, has been stirred up again. This follows the publication of new research by index provider S&P Dow Jones into the performances of managed funds in Australia.
Known as the SPIVA® Australian Scorecard, S&P has looked at 608 Australian equity funds, 294 international equity funds and 66 Australian bond funds, and compared their performances (after fees) over 1 year, 3 years and 5 years ending 30 June 2016 to the performances of the most relevant benchmark.
The results are pretty alarming. Most active funds underperformed compared to their benchmark index.
The table below shows the data. For example, 59.7% of Australian equity funds failed to beat the S&P/ASX 200 over the 12 months to 30 June 2016, 65.7% of funds failed to do it over 3 years, and 69.2% of funds didn’t achieve it over the 5 years.
Percentage of Funds Outperformed by the Index
Small and mid-cap funds did better. While 61.3% underperformed over 1 year compared to their relevant benchmark, only 38% underperformed over a 5-year time horizon. 62% outperformed over this period. Moreover, the outperformance was quite material. The median small/mid cap fund outperformed the index (S&P/ASX Mid-Small Index) by 3.58% pa, while a fund at the 25th percentile outperformed by 6.86% pa.
For fixed income, international equity and property security funds, the results were pretty dismal. Around 90% of these funds underperformed over 3 years and 5 years, and over 80% over 1 year.
If the size of the fund is taken into consideration, a slightly different and rather surprising outcome results. On average, bigger funds in size do better than smaller funds. So, while most equity funds underperformed, when they same results are weighted according to size, equity funds have marginally outperformed over 5 years, and largely performed with the benchmark over 3 years.
Conclusions? Well I think there are 3 main ones, which are:
- A tick to small/mid cap active fund managers;
- A tick to bigger active equity fund managers;
- Crosses for active bond, international equity and property security funds.
ETFs vs active funds such as LICs
Most exchange-traded funds (ETFs) are passively managed and track benchmark indices. Typically, they have low management fees. Over time, they should perform as well as the benchmark index less a fraction (the management fee), nothing more, nothing less.
Listed investment companies (LICs) are typically actively managed, often by the same managers looking after the investments of managed funds. On the basis of the SPIVA® Australian Scorecard, there is a prima facie case for considering the broad based equity LIC s and the specialist small/mid cap LICs. Let’s see how they are measuring up in a performance sense, and trading relative to their NTA (net tangible assets).
The Major LICs
There are three majors listed investment companies that offer access to broad based, actively managed equity portfolios – AFIC or Australian Foundation Investment Company (AFI), Argo Investments (ARG) and Milton Corporation (MLT). They are big, professionally managed and very credible investment companies. Milton Corporation, for example, was listed on the ASX in 1958 and has paid a dividend to its shareholders every year since.
These LICs essentially invest in the major blue chip companies, placing considerable emphasis on companies that have reliable earnings, pay fully franked dividends and have an ability to grow these dividends. Because they are internally managed and have scale, management costs are low. An investment précis is set out below.
Over the last couple of years, these LICs have underperformed relative to the index. All are below index for the last 12 months to 30 September. Over longer periods (10 years), all have delivered index or marginally better than index performance.
Major Listed Investment Companies
Returns to 30/9/2016. Source: Respective Managers
For a larger version of this chart, click here.
Apart from investment objective, performance and fee, another consideration is the premium or discount shares at which listed investment company are trading on the ASX compared to the company’s NTA or net tangible assets per share.
Unfortunately, LICs are only required to report their NTA once a month, although some more “investor friendly” managers have moved to once a week, and some are now doing it daily. Here is our calculation of the NTA as at reporting date (30 September), and our estimate as at close of business last Friday.
Discount/Premium (as at 30 September 2016)
*NTA sourced from Company Reports
Estimated Discount/Premium (as at 14 October 2016)
*NTA estimated by Switzer Super Report, based on reported 30 April NTA adjusted for the movement in the S&P/ASX 200 Accumulation Index
AFIC’s premium has widened to almost 4%, making the stock somewhat expensive. Given its underwhelming investment performance over the last 5 years, it is arguably a switching proposition (sell AFIC, buy Milton or Argo). With both Argo and AFIC trading at small discounts, there is not much to choose between the two, but because we ascribe a little more weight on recent investment performance, our ranking is:
- Argo (ARG)
- Milton Corporation (MLT)
- Australian Foundation (AFI)
Small/Mid-cap LICs
The SPIVA® Australian Scorecard is in the main quite supportive of small/mid cap equity funds, with outperformance often quite material. In terms of listed investment companies, three of the standouts are WAM Capital (WAM), Mirrabooka Investments (MIR) and Contango Microcap (CTN).
Geoff Wilson’s WAM Capital Limited (WAM) has a fantastic track record. One of the largest listed investment companies at circa $1.26 billion, it trades at a premium to net tangible asset backing (NTA), so investors pay to access this performance. On 30 September, this premium was 12.2%.
The company runs an actively managed portfolio of undervalued growth companies, which are generally found in the small to medium industrial sector. WAM also provides exposure to relative value arbitrage and market mispricing opportunities. Performance has been very strong, as shown in the table below, which compares it to the fund’s benchmark of the All Ordinaries Accumulation Index. If, for example, the 1-year performance had been compared to the midcap 50, the outperformance would only be 1.5%.
WAM Capital Ltd (WAM)
Another LIC, Mirrabooka (ASX: MIR) specialises in investing in small and medium sized companies located within Australia and New Zealand. It defines these as companies that fall outside the top 50 listed companies by market capitalization. Typically, it owns 50 to 80 stocks. On 30 September, Mirrabooka was trading at a premium to NTA of 21.4%.
It benchmarks against an average of the Midcap 50 and Small Ordinaries Index, including franking credits. Performance has not been as strong recently on a relative basis, although 5- and 10-year performances are above benchmark. (Data quoted is to 31 Augusts as Mirrabooka is yet to update performance to 30 September).
Mirrabooka Investments Limited (MIR)
Contango MicroCap Limited (CTN) is Australia’s longest running micro- cap LIC. Founded in 2004, this $190m LIC aims to achieve of a long term return over and above the benchmark ASX All Ordinaries Accumulation Index and to also pay regular and franked dividends. To achieve its objective, the fund invests in a diversified portfolio of ASX listed micro-cap stocks with a market cap of between $30 million and $350 million. On 30 September, it was trading at a discount to its NTA of 14.0%.
Performance has been robust in both an absolute and relative sense. In the 12 months to June, it returned 19.44%, and since inception, has returned 15.8% pa. Over most time periods, it has outperformed its benchmark (All Ordinaries Accumulation index).
Contango Microcap Limited (CTN)
Although Mirrabooka’s share price has fallen since 30 September, reducing the premium to around 16.5%, it is still expensive and on recent investment performance, hard to substantiate. WAM is also expensive, but given its outstanding track record, should be considered. Contango invests in small and microcap companies only (rather than mid-caps such as WAM), and given it is trading at a discount, is worthy of consideration for exposure to this part of the market.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
