Not all active managers are equal

Our research demonstrates that while, on average, active managers will underperform a benchmark after fees, a select number have generated significant outperformance – and that the market has rewarded this outperformance with substantial investment. This outperformance will make a meaningful difference to those invested in these actively managed funds.

Nov 18, 2020

5 minutes

Sangeeth Sewnath
Our research demonstrates that while, on average, active managers will underperform a benchmark after fees, a select number have generated significant outperformance – and that the market has rewarded this outperformance with substantial investment. This outperformance will make a meaningful difference to those invested in these actively managed funds.

The fast view

  • The vast majority of investors’ assets are managed by a small number of managers, which therefore represent the bulk of “experienced performance” for clients. With this in mind, we examined asset-weighted ASISA1 performance data.
  • The largest three active managers, Coronation, Allan Gray and Ninety One, account for over 30% of all unit trust assets and 55% of assets in the Multi-Asset High-Equity (“MAHE”) sector.
  • We compared the performance of the MAHE funds managed by these three managers to those managed by the top three passive managers, again based on asset size, but also with a longer than two-year track record. (These three passive managers account for 6% of assets in the Multi-Asset High Equity sector.) We used the Willis Towers Watson balanced benchmark,2 which is a challenging benchmark with high offshore and equity weightings, calculated by an independent consultant.
  • The active group outperformed the benchmark by 1.8% (annualised) over rolling three and five years to the end of September 2020. In contrast, the passives underperformed by 1%,3 creating a 2.8% differential. For an investor, that’s the difference between your money multiplying 21 times versus 12 times, over 20 years.

As an active, risk-aware investment firm, we believe that active returns deliver significant value to investors. However, it is clear that not all active managers are equal, nor are all strategies directly comparable. The MAHE sector has a large number of funds that employ various strategies – active, passive, smart beta and a blend. To isolate performance as experienced by the average client, we selected the largest managers’ largest MAHE funds – both active and passive. This enabled us to compare performance as representatively as possible. A great proportion of investors’ assets are in a small number of trusted active managers’ hands, namely Coronation, Allan Gray and Ninety One. We have analysed these managers’ performance against both a challenging, independently calculated benchmark and against counterpart passive providers, and have compelling evidence of the persistent value of active management.

Simplistic analyses of returns ignore risk. In a highly concentrated and occasionally inefficient market such as ours, the value of active management comes to the fore during times of market stress. For example, market performance in the wake of the pandemic has largely been driven by just two shares, Prosus and Naspers. Together they constitute more than a third of the market, and respectively returned around 29% and 46% for the year to date.4 Without their contribution, the year-to-date return from the market as a whole falls dramatically. The difference between including and excluding just these two shares is more than 16%, as can be seen in Figure 1.

From a portfolio management perspective, the concentration of these shares in the “Global” SWIX40 Index makes it very difficult to beat the index when they are rising strongly, and consequently flatters passive performance. This effectively penalises intelligent risk management, which down-weights shares as their valuations become more and more stretched. Nevertheless, skilled active managers have added value in excess of the benchmark over this period, without taking on irresponsible levels of risk. To do this is not impossible, but demands conviction, both as an investor and as a manager, over the medium to long term.

Figure 1: A small number of shares can make an outsize difference

A small number of shares can make an outsize difference

Source: Investec Securities

In the current environment, a small number of large shares have outperformed dramatically. However, they can reverse direction quickly and punish investors who have unwittingly exposed themselves to such a situation. Combined with the potential value add an experienced financial advisor can deliver, active managers can and do improve risk-adjusted returns dramatically.

In the current environment, a small number of large shares have outperformed dramatically.

Take the case of a 40-year old, saving for retirement at 65, 25 years from now. In such a case, an additional 2% per annum results in the investor having twice as much income at retirement. And from the above figures shown for the MAHE funds, this is achievable.

Not only is this outcome possible, it is best executed by taking advantage of independent financial advice.

This is because there are two crucial decisions investors face.

1 Choosing the correct risk profile

Investors who are saving for retirement are usually unduly cautious, investing in low risk (low equity) portfolios. By taking professional advice, they would be matched to the correct, higher risk profile. In doing so, they can potentially double their replacement ratio (A). Financial coaching reduces not only the risk of incorrect profile selection upfront, but the risk of locking in losses by switching to cash during a crash. An independent financial advisor can help you avoid the behavioural mistakes and select the non-obvious opportunities (B).

A. What is a replacement ratio?
Your replacement ratio is the percentage of your final monthly income you will enjoy as an actual post-retirement income, based on how much you have saved. If you have saved enough for an annuity that provides you R75 000 relative to a final salary of R100 000, then you have a replacement ratio of 75%. High ratios are therefore a very good thing.

B. Inefficiency in emerging markets
“Chinese investors have generally failed to pick the top-performing actively managed funds in the country, even though more than 85 per cent of them outperformed their passive rivals net of fees over 12 months and three years, according to Morningstar. The data provider’s most recent China Active/Passive Barometer, which measures the performance of onshore, China-domiciled active funds against their passive counterparts, shows that “investors have generally failed to choose above-average, active stock-heavy funds”. The findings reflect risk aversion among investors, amid economic uncertainty and geopolitical tensions, but they also illustrate how hard it is for investors to choose outperforming active managers, especially in uncertain times.”
- The Economist, 14 August 2020.

 
2 Choosing the right funds

Analysing Morningstar’s performance data net of fees reveals that simply equal weighting investments between the largest three active managers’ balanced portfolios (the Ninety One Opportunity Fund, Allan Gray Balanced Fund and Coronation Balanced Plus Fund), delivered 1.8% over rolling three and five years in excess of the aggressive Towers Watson balanced benchmark. This stands in contrast to allocating equally to the top three passive providers’ multi-asset funds (the Nedgroup Investments Core Diversified Fund, 10X High Equity Index Fund and Satrix Balanced Index Fund), which delivered -0.99% net of fees behind the same balanced benchmark over rolling three years and -1.08% over rolling five years.5 The impact of this additional return from the combination of financial advice and active management is considerable.

The impact of this additional return from the combination of financial advice and active management is considerable.

This positive outcome for active managers is also evidenced in the Equity funds category. The leading tracked index in South Africa is the Capped SWIX Index. The rolling three-year average annualised return (to end September 2020) of the Ninety One SA Equity Fund, Allan Gray SA Equity Fund and Coronation Top 20 Fund is 2.16%, versus that of the largest three passive equity-only funds, the Satrix ALSI Index Fund, Old Mutual Rafi 40 Index Fund and Sygnia SWIX Index Fund, which delivered an average annualised return of -0.15%. Similarly, over rolling five years, the active group returned 1.85% per annum with the passive group returning -0.42% per annum. Looking even further back, the ten-year returns are 1.52% per annum and -1.36% per annum for the active and passive groups respectively.6

When to re-evaluate your strategy

Our research clearly demonstrates that while, on average, active managers will underperform a benchmark after fees, a select number have generated significant outperformance – and that the market has rewarded this outperformance with substantial investment. This outperformance will make a meaningful difference to those invested in these actively managed funds. It is evident that with more than half of the assets invested in the MAHE sector having been exposed to this active outperformance, it was not that difficult a decision.

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1 The Association for Savings and Investment South Africa (ASISA).
2 42% Capped SWIX, 13% ALBI and 5% IGOV, 5% STeFI, 5% ALPI, 26% MSCI ACWI, 4% JP Morgan Global Gov Bond, 3% FTSE EPRA/NAREIT Developed Index.
3 Past performance figures should not be taken as a guide to the future. Source: Morningstar. Returns to 30 September 2020, on a bid-to-bid basis with gross income reinvested, in South African rands. Performance shown is net of highest management fees (A class). The benchmark is the Capped SWIX and prior to that, the SWIX, and prior to that, the FFBM (ALSI half weighted Resources).
4 Year to date to September 2020.
5 Past performance figures should not be taken as a guide to the future. Source: Morningstar. Returns to 30 September 2020, on a bid-to-bid basis with gross income reinvested, in South African rands. Performance shown is net of highest management fees as per the share class indicated.
6 Past performance figures should not be taken as a guide to the future. Source: Morningstar. Returns to 30 September 2020, on a bid-to-bid basis with gross income reinvested, in South African rands. Performance shown is net of highest management fees (A class).

Authored by

Sangeeth Sewnath
Deputy Managing Director

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All information provided is product related and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Ninety One Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www.ninetyone.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, RMB, 3 Merchant Place, Ground Floor, Cnr. Fredman and Gwen Streets, Sandton, 2196, tel. (011) 301 6335. Ninety One SA (Pty) Ltd is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA).

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