In all the recent talk on the rise of passive investment strategies, their active counterparts have been steadily compounding outperformance. The case for active management is stronger than ever, especially following one of the toughest investment years in living memory.
We are surrounded by a cacophony of research, data and commentary that seldom looks beyond the current year. Witness the common financial press. When it does refer to particular or aggregate outcomes produced by investment managers and superannuation funds utilising active investing, it inevitably refers to the shorter term and compares to a relevant benchmark. The benchmark or index, of course, does not take active decisions, it is simply a ‘weighing device’, typically based on market-cap criteria and the net sum of investor behaviour at any given point in time.
By contrast, with an eye to producing superior, risk adjusted long-term returns, the thoughtful active manager will use judgment to avoid such short-term traps and invest in the inevitability of economic and market growth, and mean reversion over time. It makes sense that there will be periods of underperformance because, after all, this risk recycles as a source of future long-term excess return.
So how have active approaches done? The Mercer Australian Large Cap Share Performance Survey for the 20 years to end December 2020 shows that the S&P/ASX 300 (All Ords before 1/4/2000) returned 8.1% pa on a compound basis. Of the 27 active strategies in the survey, 26 beat the market with a median result of 9.4% pa, compounding at a very respectable 1.3% pa above the market. The upper quartile compounded at 10.5% pa, beating the market by 2.4% pa. Even the lower quartile mark of 8.8% pa outperformed the broader market. These results do not include the effect of franking and are shown on a before fees basis.
Over a 20-year timeframe, investing $10,000 at a median return of 9.4% pa produces a balance of $60,304. If, rather, one invested in an index fund or market ETF and received a before fees return of 8.1% pa, the final balance would amount to a far lower $47,480.
For comparison, Ausbil Australian Active Equity Fund has delivered a 20-year compound return of 10.3% pa (gross of fees) turning $10,000 into $115,231. Since inception in 1997, the same Fund has delivered a compound return of 11.0% pa, an excess return of 2.9% pa (gross of fees). Given the evidence, the role for patient, active investing in Australian equity portfolios is compelling.
Given the vast array of available investment strategies and vehicles it is difficult to generalise about the average level of investment management fees and what level is and isn’t reasonable. Investors though should remain considered in this area because the compounding effect of fees can genuinely interfere with long-term growth objectives. It is also important to distinguish between investment, administration and advice fees. Only investment management fees should be attributed to investment portfolios and included in net fee calculations. To enjoy the benefits of an active approach, investors should ensure that excess returns are expected to well exceed fees on a rolling long- term basis.
Einstein is reputed to have claimed that, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it”. Whether government legislation, regulation, advice or investor behaviour, any cause for impatience around access to capital or the lengthy incubation period necessary to produce valuable active returns, will only serve to interfere with our industry’s capacity to deliver that which our customers desire most – the ability to develop an independent financial confidence that will go the distance. After 45 years across a typical working career, who would deny them?