Transcript How to Pick Managed Investments

A differentiated approach to asset
allocation and product selection
Travis Morien
Compass Planners Pty Ltd
http://www.travismorien.com
Tribeca Targeting High Net Worth Investors Conference
25th and 26th October 2004, Four Seasons Hotel Sydney
Active vs. passive investing
Pictures by Vanguard Investments
“Properly measured, the average actively managed dollar
must under-perform the average passively managed dollar,
net of costs” (Bill Sharpe)
Distribution of Manager Returns vs. Benchmark
Pre-fees:
Post-fees:
Good
Managers
-4%
+4%
Average = 0%
-5%
+3%
Average = -1%
Source: “Arithmetic of Active Management”, Financial Analyst Journal, Jan 91.
Percentage of active funds
underperforming their benchmark index
after fees in the 5 years to 31 March 2004
100%
80%
60%
40%
20%
0%
100.0%
51.0%
52.0%
Aus shares
Intl shares
75.0%
76.0%
Aus listed
property
Aus bonds
Underperforming
Source: Mercer/Morningstar IDPS Survey
Aus cash
Outperforming
Number of Australian Share managers outperforming the S&PASX300 Index,
post fees (12 months to 31 July) and value minus growth returns
Above Index
Below Index
60
40
20
0
12
10
18
7
22
8
33
35
12
16
54
28
21
28
56
58
2003
2004
5
-20
43
-40
-60
-80
1996
1997
1998
1999
2000
2001
2002
25
20
15
Value outperforms
10
5
0
-5
-10
Growth outperforms
-15
Citigroup BMI Value - Citigroup BMI Growth
Top chart source: Mercer/Morningstar IDPS Survey Bottom chart source: Dimensional Fund Advisors
Every US large cap fund with a 15 year history vs the S&P500 and CRSP 110 indexes. 15 Years ending 31 December 2001 (285 Funds)
Graphic by Dimensional Fund Advisors
Survivorship bias: amount median prices
are overstated per year
3 years 5 years 7 years
Australian shares
Global shares
Fixed interest
0.77%
0.79%
0.09%
0.25%
0.39%
0.20%
0.41%
0.66%
0.19%
Balanced pooled funds
0.52%
0.22%
0.20%
Source: Russel Investment Group, periods ending 30 June 2004,
“Insights” IN107.
Source: PM Capital
"Investors continue to sour on stocks. So far this year, investors have
made net withdrawals of $11.3 billion from their stock mutual funds
according—including a hefty $3.7 billion just last week—according to
AMG Data Services.” Source: Gregory Zuckerman, "Investors Rush to
Buy Bonds, Fleeing Stocks," Wall Street Journal, March 11, 2003
S&P500 index 2000 - 2003
1/10/03
1/07/03
1/04/03
1/01/03
1/10/02
1/07/02
1/04/02
1/01/02
1/10/01
1/07/01
1/04/01
1/01/01
1/10/00
1/07/00
1/04/00
1/01/00
1550
1450
1350
1250
1150
1050
950
850
750
S&P500 data source: http://finance.yahoo.com
Annual returns of “buy and hold” index vs actual
annual returns enjoyed by US mutual fund investors
from 1984 to 2002
14.00%
12.22%
11.70%
12.00%
10.00%
8.00%
6.00%
4.00%
4.24%
2.57%
2.00%
0.00%
US Stocks
Index
US Bonds
Mutual fund investor
Source: DALBAR, Inc. Media release of 2003 update of “Quantitative Analysis of
Investor Behaviour” study.
The diverse world of passive investing
•
•
•
•
•
Traditional index funds (BGI, Vanguard)
Enhanced index funds (BGI, Macquarie)
Exchange traded funds (Streettracks)
“Style indexed” funds (Vanguard ASHY)
Asset class funds (Dimensional)
Beating the market - passively
Fama and French’s Three Factor Model
Graphic by Dimensional Fund Advisors
Fama/French indexes on the US market
Annualised returns July 1926 – August 2004
16.00%
14.00%
12.00%
10.00%
8.00%
14.92%
13.26%
11.99%
10.37%
9.56%
9.60%
6.00%
4.00%
2.00%
0.00%
Large
Value
Small
Neutral
Figures do not include fees, taxes or other costs and
past performance may not be indicative of future
results.
Growth
Source: Dimensional Fund Advisors
F/F Lrg Val
F/F Lrg Ntl
Jul-02
Jul-96
Jul-90
Jul-84
Jul-78
Jul-72
Jul-66
Jul-60
Jul-54
Jul-48
Jul-42
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
-5.00%
-10.00%
-15.00%
Jul-36
10 year rolling returns US large cap value, neutral and
growth, July 1926 to August 2004
F/F Lrg Gro
10 year rolling returns US small cap value, neutral and
growth, July 1926 to August 2004
40.00%
30.00%
20.00%
10.00%
F/F Sml Val
F/F Sml Ntl
F/F Sml Gro
Jul-02
Jul-96
Jul-90
Jul-84
Jul-78
Jul-72
Jul-66
Jul-60
Jul-54
Jul-48
Jul-42
-10.00%
Jul-36
0.00%
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
F/F Lrg Val
F/F Lrg Ntl
F/F Lrg Gro
Jul-04
Jul-98
Jul-92
Jul-86
Jul-80
Jul-74
Jul-68
Jul-62
Jul-56
Jul-50
Jul-44
Jul-38
Jul-32
Jul-26
Historical drawdown US large caps
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
F/F Sml Val
F/F Sml Ntl
F/F Sml Gro
Jul-03
Jul-96
Jul-89
Jul-82
Jul-75
Jul-68
Jul-61
Jul-54
Jul-47
Jul-40
Jul-33
Jul-26
Historical drawdown US small caps
GROWTH OF DOLLAR (LOG PLOT)
100
Value of Dollar
Global value 17.75%pa
10
Global small 16.06%pa
1
Global large 13.78%pa
0.1
12/79
1/83
2/86
3/89
4/92
5/95
6/98
7/01
8/04
Time Periods: 1/80 to 9/04
Figures do not include fees, taxes or other costs and
past performance may not be indicative of future
results.
Source: Dimensional Fund Advisors
9/07
GROWTH OF DOLLAR (LOG PLOT)
100
Value of Dollar
Australian value 19.97%pa
10
Australian large 13.02%pa
1
Australian small 12.06%pa
0.1
12/79
1/83
2/86
3/89
4/92
5/95
6/98
7/01
8/04
Time Periods: 1/80 to 9/04
Figures do not include fees, taxes or other costs and
past performance may not be indicative of future
results.
Source: Dimensional Fund Advisors
9/07
Industry follows academia
GROWTH OF DOLLAR (LOG PLOT)
8
Value of Dollar
MSCI World
Index A$
Emerging markets vs.
MSCI world
1
MSCI Emerg
Mkts Free A$
0.3
12/87
1/90
2/92
3/94
4/96
5/98
Time Periods: 1/88 to 9/04
6/00
7/02
8/04
9/06
Adding emerging markets to an international shares portfolio
MSCI World Index + MSCI Emerging Markets Free Index,
January 1988 to September 2004
13.00%
100%
12.00%
90%
Annualised return
80%
70%
11.00%
60%
50%
10.00%
40%
Percentage
emerging
markets
30%
9.00%
20%
8.00%
10%
0%
7.00%
4.00%
4.50%
5.00%
5.50%
6.00%
Monthly standard deviation
6.50%
7.00%
Choosing active funds
What do we want from active funds?
• Active funds potentially can have higher
performance
• Passive funds are not available for all asset
classes
• Perhaps something very different to the
index for diversification
Core/Satellite Approach
Sector Index Funds:
 Tailor strategic allocation
 Increase index core where
confidence in active is
low
Cash
Australian
Shares
Fixed
Interest
Property
International
Shares
Active “Satellite”
Index Core
Graphic by Vanguard Investments
The cost of active management from a
low tracking error manager
80% x 0.286%pa + 20% x 6.356%pa = 1.5%pa
Wholesale index MER + aggressive fund MER
= low tracking error MER
Median
Tracking Error in Australian Shares Specialist from Nov 1987 to Aug 2004
Median versus ASX-300 (before tax and before fees)
13.0%
11.0%
Tracking Error (%pa)
9.0%
7.0%
5.0%
3.0%
1.0%
Nov 1987
Feb 1989
May 1990
Aug 1991
Nov 1992
Feb 1994
May 1995
Aug 1996
1 Year Rolling Tracking Error
Nov 1997
Feb 1999
May 2000
Aug 2001
Nov 2002
Feb 2004
Median
Tracking Error in Overseas Shares Specialist from Feb 1986 to Aug 2004
Median versus MSCI (before tax and before fees)
14.0%
12.0%
Tracking Error (%pa)
10.0%
8.0%
6.0%
4.0%
2.0%
Feb 1986
Jun 1987
Oct 1988
Feb 1990
Jun 1991
Oct 1992
Feb 1994
Jun 1995
1 Year Rolling Tracking Error
Oct 1996
Feb 1998
Jun 1999
Oct 2000
Feb 2002
Jun 2003
“The whole concept of dividing it up
into "value" and "growth" strikes me
as twaddle. It's convenient for a
bunch of pension fund consultants to
get fees prattling about and a way for
one advisor to distinguish himself
from another. But, to me, all
intelligent investing is value
investing.”
Charlie Munger
The Style Universe
Growth
Value
Growth
Value
Perpetual, MBA,
Dimensional
Relative Value
Colonial FS,
Credit Suisse
Lazard
GARP
BT, ING
Neutral
UBS
Indexed
Vanguard
Graphic by Vanguard Investments
Tax efficiency
•
•
•
•
•
•
•
Income/growth and franking credits
Turnover
Tax loss selling
Hold range
Short vs. long term CG realisations
Tax liability on existing portfolio
Consider your turnover as well, how often will you
switch an active manager compared to a passive one.
Vanguard is now reporting after tax returns,
Morningstar will start tracking them from next year.
Capacity issues
• Market size (large cap vs. small, domestic
vs. international)
• Portfolio turnover
• Contrarian vs. momentum
• Active positions/index weightings (tracking
error)
• Large size offset by possible new
opportunities and market clout.
Why does turnover matter?
• Ruins tax efficiency
• Increases brokerage and market impact
costs, making it increasingly difficult to
outperform as the portfolio gets larger.
• According to a US researcher, the Plexus
Group, managed funds incur costs of around
0.8% on each side of a transaction. It costs
about 1.6% round trip to buy and sell a
stock.
Key person risk
•
•
•
•
•
Skill vs. process
Incentive structure
Institution vs. boutique
Staff equity ownership
Eating their own cooking
Suggestion for picking active funds
1. Avoid “index huggers” that charge a full active MER.
Funds with concentrated high conviction portfolios
may actually represent better value on a price per
active position basis.
2. Avoid tax inefficient funds for investors on high tax
rates. The tax inefficiency penalty can cost several
percentage points per year. If you must use inefficient
funds, use super.
3. Avoid “growth at an unreasonable price” funds and
funds with excessive turnover. Seek out funds with a
value philosophy, but not necessarily funds
pigeonholed into a “value” classification.
4. Look for fund managers with a performance culture
rather than a FUM gathering culture that adequately
reward their key staff.
Asset allocation and risk
management
"The essence of risk management lies in
maximising the areas where we have some
control over the outcome while minimising
the areas where we have absolutely no control
over the outcome and the linkage between
effect and cause is hidden from us."
Peter Bernstein
Bernstein, P. L. Against the Gods: The Remarkable Story of Risk. Wiley;
New Ed edition (1998)
“The determining question in structuring a
portfolio is the consequence of loss; this is far
more important than the chance of loss."
Peter Bernstein
Bernstein, P. L. Management of Individual Portfolios. The Financial
Analysts Handbook; Levine, S. Ed.; Dow Jones Irwin Inc: Homewood Il,
1975.
• Risk is the probability of not having
sufficient cash with which to buy something
important.
• Risk is a function of a portfolio's assets and
its liabilities, in particular the cash flow
between the two over time.
Dividends vs. interest, ASX200 index vs. treasury bills
$8,000
$300.00
$7,000
$250.00
$4,000
$150.00
$3,000
$100.00
Annual income
$200.00
$5,000
$2,000
$50.00
$1,000
Shares capital
Cash capital
Dividends
Cash interest
Dec-2003
Dec-2002
Dec-2001
Dec-2000
Dec-1999
Dec-1998
Dec-1997
Dec-1996
Dec-1995
Dec-1994
Dec-1993
Dec-1992
Dec-1991
Dec-1990
Dec-1989
Dec-1988
Dec-1987
Dec-1986
Dec-1985
Dec-1984
Dec-1983
Dec-1982
Dec-1981
$0.00
Dec-1980
$0
Dec-1979
Capital value
$6,000
CPI Inflation
Source: Reserve Bank of Australia
Income planning for pensions
• Dividends are fairly reliable for diversified
portfolios
• We can’t eliminate capital volatility but we can
make it less relevant through portfolio structuring.
• Fund near term capital withdrawals with cash, if
you aren’t drawing down on shares then share
market volatility is sidestepped.
• This turns asset allocation into a mere budgeting
exercise! Put aside enough cash to cover the
dividend shortfalls and you’ll reduce your need to
sell shares.
Evolving asset allocation during the
accumulation phase
$1,200,000.00
$1,000,000.00
$800,000.00
$600,000.00
$400,000.00
$200,000.00
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
$0.00
Growth assets
Medium risk assets
Low risk assets
Three dimensions of risk profiling
• Tolerance of loss
• Timing of cash flows (time frame)
• Tolerance of tracking error,
unconventionality and complexity
Large Tilted
GROWTH OF DOLLAR (LOG PLOT)
20% Australian large
100
20% Australian value
Annualised
Return %pa
14.01 16.36
Total
Large
Portfolio
Cumulative
Return %
2468
4150
Monthly
Standard
Deviation %
4.19
3.92
Monthly
Average
Return %Tilted
1.19
1.35
10% Australian small
20% global large
20% global value
Value of Dollar
10% global small
10
50% Australian large
50% global large
Portfolio
1
12/79
Annualised
Standard
Deviation %
1/83
2/86
3/89
4/92
5/95
6/98
7/01
8/04
14.50 13.59
9/07
Time Periods: 1/80 to 9/04
Source: Dimensional Fund Advisors
Jan-04
Jan-02
Jan-00
Jan-98
Jan-96
Jan-94
Jan-92
Jan-90
Jan-88
Jan-86
Jan-84
Jan-82
Jan-80
Portfolio drawdown (maximum loss)
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
Large
Tilted
Source: Dimensional Fund Advisors
Disclaimer:
This article contains the opinions of the author but not necessarily the
author’s employer or any of the individuals or companies mentioned in
this presentation, and do not represent a personal recommendation of
any particular security, strategy or investment product. The author's
opinions are subject to change without notice.
Information contained herein has been obtained from sources believed
to be reliable, but is not guaranteed.