Photo by : Matthew Fatches, www.mattfatches.com.au Gian Pandit and Ella Brown 24 PROFESSIONAL PLANNER
Courage of conviction There is a growing sense that the time to move back into equities is drawing closer, and advisers have some decisions to make. Simon Hoyle reports. Given the events of the past three or four years, it might come as a surprise to learn that over the 20 years to the end of 2011, were the second-best performing asset class. The June 2012 Russell Investments/ASX Long-Term Investing Report says the gross return from equities was 8.7 per cent a year implying that a $100,000 investment would have grown to more than $530,000 over the period. This placed the asset class marginally behind residential real estate, which posted a 9-per-cent annual return (which would have turned a $100,000 property into a $560,000 property). Over 10 years, ranked third, with an annual return of per cent. Residential property was again the best performer at 8 per cent, while bonds snuck in at number two at just 6.4 per cent. (It should be noted that the figures quoted above are gross returns and do not take into account the effects of tax. See the chart on page 27 for relative performance results.) These analyses highlight at least two things. First, things always tend to look better for over long periods of time. And second, it s easy to pick the best performing asset class after the event. There s growing acceptance among advisers, as the Reserve Bank of Australia cuts interest rates and clients start to contemplate lower returns on cash holdings and term deposits, that a move towards growth assets may be appropriate. A survey of advisers by Zurich Financial Services found that more than two-thirds of advisers intend to move client portfolios back into equities in the coming 12 months. The Zurich survey stated that of those advisers who said they would rebalance their customers cash holdings, 94 per cent said they would move to growth assets. Specifically, 40 per cent said they would move to, 25 per cent said they would move to PROFESSIONAL PLANNER 25
international, 19 per cent said they would move to direct equities and 10 per cent said they would move to property securities. In a statement, a senior investment strategist for Zurich, Patrick Noble, said that as the market goes through its cycle, it is likely the dependence on cash will eventually diminish. How long that cycle will be, of course, depends on timing - something that we all acknowledge is notoriously hard to do. When money moves back into equities, a key decision will be whether to hire active fund managers to do the job, or to use lower-cost index alternatives, such as exchange-traded funds (ETFs). There are many reasons why a financial planner might choose an ETF to implement equities exposure for a client: uncertainty about the ability of active managers to actually add value; cynicism over the fees charged by so-called active managers who really just hug a market index; and the relative cost of ETFs compared to actively managed funds, to name just three. Ella Brown, head of fundamental equities for AMP Capital Investors, says a fundamental, active approach to managing money is clearly different from passive and from quantitative management. Passive is robotically going out and buying a benchmark or an underlying index, Brown says. Quant, obviously, is looking at this is going to sound trite the non-fundamentals : much more formulaic analysis; repetition of patterns; et cetera. And then the fundamental products are built on in-depth company research, with a starting point or an underlying premise that if you do enough analysis and do the correct analysis, it is possible to identify stocks that are mispriced, based on those fundamentals, and exploit that for a client s portfolio. Buying an index fund, of course, means buying each and every stock (or mix of stocks designed to replicate each do i feel lucky? well do you? Not only is it easier to pick the best performing asset class accurately with the benefit of hindsight, it s also possible to pick the best performing fund manager with a remarkable degree of accuracy. However, the task of picking today which fund manager or managers will be among the best performers when measured three or five years (or longer) from now is a much more difficult job. In this regard, it s vital to be able to distinguish between a fund manager that is good, and one that is merely lucky. A lucky fund manager might be top of the performance surveys today, but there s no certainty at all that it will still be there at the end of the relevant or appropriate time period for a client. Tom Whitelaw, a research manager at Morningstar, says there are steps that investors can take to separate skill from luck, to improve the chances of employing a fund manager that knows what it s doing, and therefore improve the chance of picking a managed fund that will outperform its nominated benchmark. Over a short period and with little to go on other than performance, it s almost impossible to separate skill from luck, Whitelaw says, in his paper Separating skill from luck, published in June. Whitelaw adds that armed with the right tools, and by looking at the right things, it s much easier to separate the competent from the fortunate. Looking in the right place means not putting too much weight on the manager s historical performance. Whitelaw says it s necessary to drill down to look at how the returns were achieved. We therefore spend a lot of time with the portfolio manager and investment team, he says. We assess their experience and goals to make sure they align with the strategy. Key person risk is often an important issue, so it s nice to have confidence in the team, and make sure resources are not being spread too thinly. We also focus on remuneration, favouring managers whose incentives are aligned with those of their investors. Whitelaw says that managers with skill are generally able to demonstrate why they invested in specific stocks, sectors, or themes when they did. A researcher therefore must ensure that the investment performance is truly a reflection of a clear process. Among lucky managers, portfolio attribution is also likely to be topheavy, a few blue-sky stocks accounting for most outperformance, Whitelaw says. In a concentrated fund, the skill of the fund manager is paramount. There s less opportunity to hide a bad investment decision in a portfolio of 30 stocks than there is in a portfolio of, say, 70. Head of ratings for van Eyk Research, Matt Olsen, says the manager s skill is particularly important, particularly in a concentrated offering, and it s not just the individual portfolio manager, it s the whole team generating investment ideas. It s the process, it s the portfolio construction process, the risk management that is inherent in the process, Olsen says. We like to see good research being conducted, where analysts are generating unique insights and where they re doing proprietary research. For a concentrated manager, in terms of risk-adjusted returns, obviously skill is a key component; the breadth of the process in terms of the number of stocks and how often stocks are traded is important; and also the portfolio-construction efficiency. So they re the three key things we think about. In terms of management skill, we want to see things that are fundamentally based, economically sound investment ideas; and manager skill is crucial in a concentrated offering. 26 PROFESSIONAL PLANNER
Investment returns for the 20 years to December 2011 10% 8% 6% 4% 2% 0% 9.0 8.7 7.0 9.2 9.0 8.1 6.6 8.2 Residential investment property 6.0 5.4 Gross return After-tax - lowest MTR After-tax - highest MTR Super 4.6 and every stock) in the index, regardless of the relative valuations of those stocks. What that means is you often end up with exposure to things that maybe you didn t really want, Brown says. With the benefit of hindsight, by allocating to the global index if you d just bought passive global ex-australia you probably ended up with a lot more Japan than you wanted for the past 15 years, and more recently you probably ended up with an awful lot more of Europe than you wanted. But that is the nature of buying passive, if you re just letting somebody else pick the stocks. Quant does try to exploit mispriced stocks, and fundamental is an additional layer on top of that. As a starting point, it s very difficult to beat any benchmark. The benchmark is a very robust competitor, but if you are structuring a fundamental team, you need different skills on that team than you would need on a quant team, and you need the people who can do the analysis and who are persistently correct about identifying mispriced stocks because having 10 analysts isn t good enough. You ve got to have 10 good analysts to be able to outperform and deliver what the clients are looking for. If you blindly buy an ETF blindly is an exaggeration and you re getting all of your exposure through passive or an ETF, you are not paying for that stock-picking talent which is out there. Two factors influence the movements of share prices: fundamentals and sentiment. Separating one from the other is the role of the professional fund manager. And it s the job of the active fund manager to produce investment returns that exceed a market index or some other benchmark. If they don t if, for example, they produce benchmark or benchmark-like returns then they re simply not worth their fees. Gian Pandit, a senior portfolio manager for AMP Capital 5.6 REITs 7.6 3.9 6.5 bonds 4.1 3.3 2.1 Cash 3.5 6.7 4.9 Overseas (hedged) 4.8 4.3 3.4 4.4 Overseas (unhedged) 6.5 6.5 4.2 5.8 Global REITs (unhedged) Source: Russell Investments/ASX Investors, runs a concentrated equity strategy for the manager. He says the aim of the portfolio management team is to generate returns in excess of the fund s benchmark, thereby justifying its active-management fees, but with an eye on capital preservation. AMP marries its analysts bottom-up stock selections with a top-down view of the market and the world gleaned from the extensive resources of the AMP group. These include big-picture economic analyses, as well as input from AMP s fixed-interest team. Pandit says he is not constrained by having to adhere to the traditional growth or value investment styles. The AMP fund is free to choose stocks, based on its analysts fundamental research, for whatever valuation reasons it sees fit. It s not style-agnostic we believe in styles but it s being style-unconstrained, Pandit says. There s a stage to be in value, there s a stage to be in growth. But if you can time the movements between value and growth stocks, you can outperform in all types of markets. And that s the key. Alpha generation is key to this product. So you ve got to be able to show a financial planner that you can weather all types of markets. By having a strong team here, and the breadth of the AMP universe, we can try and achieve that. The analysts do the rigorous, fundamental bottom-up work that all of the portfolio managers in the fundamental group rely upon. Let s be clear: that s the platform, that bottom-up fundamental analysis. Matt Olsen, head of ratings for van Eyk Research, says the firm recently awarded an A-rating to the AMP Capital Equity Concentrated Fund. He says concentrated equity funds have a place in a balanced portfolio, as part of the portfolio s equity fund holdings. Concentrated funds tend to set higher return targets than mainstream equity funds, and demonstrate higher tracking error. We like the concentrated space, because it contains managers that display more conviction in terms of higher tracking error and a higher alpha-return objective, Olsen says. They concentrate those funds into their very best ideas, and investors can get access to that and it gives the investor a chance to earn a higher rate of returns, above and beyond the market index, than if there was a less concentrated, less active approach, which you see in core [equity] funds. Olsen says an investment in equities should always form part of a balanced portfolio, and concentrated funds have a role to play within the equity component. We recommend, generally speaking, one or two or three managers in the equity space that investors should consider in order to diversify risk, Olsen says. If you were looking for a slightly higher return objective, this is the right kind of fund to be looking at, because [concentrated] funds do take higher active risk than a manager that hugs a benchmark. PROFESSIONAL PLANNER 27
ACI0 I0073/ 073/B/PP Equities AMP Capital Equity Concentrated Fund is rated A by van Eyk. Property One of the largest property managers in the Asia Pacific region.* Infrastructure managers globally.** Multi-Asset Investing Ranked in the top 10 infrastructure Carefully negotiating the worst of volatility whilst seeking the best of it AMP Capital Multi-Asset Fund. Fixed Income Track record as a cornerstone investor, giving access to some of the best opportunities. To find out more speak to your Key Account Manager, call us on 1300 139 267 or visit ampcapital.com.au van Eyk Research Pty Ltd ABN 99 010 664 632, corporate authorised representative of van Eyk Financial Group Pty Ltd ABN 28 149 679 078, AFSL 402146 (authorised representative number 408625) (van Eyk) rates investment management capabilities rather than individual products. This rating is valid as at March 2012 (AMP Capital Equity Concentrated Fund) but can change or cease at anytime and should not be relied upon without referring to the meaning of the ratings, as well as the full manager report, available to subscribers at www.irate.vaneyk.com.au. Past performance information given in this document is given for illustrative purposes only and should not be relied upon as it is not an indication of future performance. van Eyk has not directed the publication of AMP Capital Investors ratings. These ratings are not intended to influence you and your client s investment decision in relation to any products managed by AMP Capital Investors and does not take into account your client s individual financial situation, needs or objectives. We recommend that you and your client do not rely on these ratings in making an investment decision and instead you seek advice from an appropriate investment adviser and read the product disclosure statement before making such a decision. *ANREV Research 2011 Asia Property / ANREV Fund Manager Survey, October 2011. **Tower Watson, Global Alternative Survey, July 2012. AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232 497) (AMP Capital), is the responsible entity of the AMP Capital Equity Concentrated Fund and the AMP Capital Multi-Asset Fund and the issuer of the units in each Fund. To invest in this Fund, you ll need to obtain the current Product Disclosure Statement (PDS) from AMP Capital. The PDS contains important information about investing in the Fund and it is important that you read the PDS before making a decision about whether to acquire, or continue to hold or dispose of units in the Fund. This information has been prepared for the purpose of providing general information, without taking account of any particular investor s objectives, financial situation or needs. You should, before making any investment decisions, consider the appropriateness of this information and seek professional advice, having regard to your objectives, financial situation and needs.