Monthly Archives: January 2016

No one at SSGA read the marketing dept memo… 27 January 2016

Last week was quieter than normal in the Winston office, and clearly, I had way too much time on my hands given the article below, but I have to say, I felt compelled to pen a short blog on how large companies sometimes struggle to stay on message, causing confusion with potential customers because of conflicting messages about what they truly believe in.

The cause of my confusion, and probably the principal cause of confusion for many investors who rely on the media to make their ‘informed’ investment decisions, was SSGA’s 24 hour press release cycle suggesting why on one hand, we should invest in ETFs during times of high uncertainty and high volatility (apparently this is what investors do during times of market stress based on SSGA’s sales observations) only to be told 24 hours later by the same brand suggesting why investing in benchmarks may not be such a good idea.  Huh?

In the blue corner, we have the SSGA ETF team weighing in at 93.5kgs…

January 19, 2016:  “ETFs benefit from market volatility” 

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SSGA’s ETF team suggest that “during times of market uncertainty many investors want (or need) to remain invested in the sharemarket, but higher levels of uncertainty make it more difficult to identify opportunities.”  This seems odd.  I would have thought that the greater the uncertainty, the greater the opportunity set. My last post highlighted how a number of ‘true to label active managers’  are doing very well in these uncertain times – you can read the blog here.

The article goes on to talk about STW, the S&P/ASX 200 ETF, which is a massively concentrated portfolio that derives the majority of its return (beta) from a small number of economic drivers, unable to avoid them because there is no view being expressed in these products. Thus, as the banks, BHP, RIO get smashed, losing billions in value along the way, we are expected to believe that more investors flock to ETFs, which is contrary to behavioural finance evidence and net flow data (see Dalbar reports) going back decades that suggest investors bail out during times such as these.   In fact, the article shows how bad this ETF can be (not great marketing I might add) when it goes on to say, “in fact, this year, our local share market has had one of the worse starts on record with only a handful of stocks on the ASX200 rising. Even Australia’s banking sector, which up until recently has been relatively immune from major global economic shocks, is showing signs of stress with shares in Australia’s largest bank, CBA, falling below $80 in January this year from a peak of $96 in March last year – that’s a 17% loss.”

Yep – by being in this ETF, you just dusted 17% in CBA; a 10% (high conviction) position in STW – a potentially avoidable loss (on paper) by thinking about where we are in the credit cycle…

And in the red corner, we have the active side of the business, weighing in at 93.6kgs…

January 20, 2016:  “equity benchmarks too risky amid volatility

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What?  I just got told by SSGA that investors look to ETFs during times of uncertainty and high volatility (or at least they want you to believe this), but this SSGA presser says that this is not such a good idea – who should we believe?

Well because the 20 January (red corner) article conforms to my own investment biases, I have to applaud this part of SSGA’s business because it sensibly “urge(s) investors to ignore benchmark weights in favour of a truly active approach amid recent and likely on-going market volatility.”

Yes, you read it right (or was that left)…

And when commenting on the market uncertainty they, “characterise (their) outlook for global markets in 2016 – lacklustre growth, risks skewed to the downside, likely fuelling bouts of investor uncertainty and market volatility.”

As a result of this outlook, the team in the red corner suggest that, “like in 2014 and 2015 we believe that to add value over the coming year we should ignore the benchmark weights and truly be active” because “the Australian equity market is dominated by financials and commodity-related sectors in terms of market capitalisation and for benchmark-driven investors this could continue to create a drag. These sectors were a significant drag on risk-adjusted returns of the benchmark index over the past twelve months, and we believe will continue to add volatility and may depress returns for the year to come.”

So whom should we believe?

Well, the red team’s active share fund has delivered 5.6% p.a. in after fee alpha since its inception in 2009, and has done so with less risk than STW – the highly concentrated index fund… (The numbers don’t lie people).

Where to from here based on this Pulitzer prize winning journal entry?

The truth of the matter (depending on your point of view), is that both products make sense at certain times.  The weighting toward passive ETFs and active managers really depends on where we are in the investment cycle.  In my view, at this stage of the investment cycle, loading up on ETFs may not be that sensible, but if you believe we are in for a multi year bull market, then maybe they are the place to be.  If you believe that we are in for more uncertainty etc, then having some smart managers picking the eyes out of the market to avoid those sectors that are at risk of further losses, also makes sense.

As they say, horses for courses…

Andrew Fairweather, Founding Partner

Could all true to label ‘active’ managers step forward please; your time has come – 7 January 2016

2015 was a pretty tough market for Australian equities and the benchmark hugging managers that track the various indexes, however, some managers had stellar years, significantly outperforming the market (and with less risk). This was especially so in the absolute return space (long short), but even there, the return dispersion between the various managers was large, and as a segment, there is enormous variance in the strategies and product structures available making it difficult to develop a standardised peer group.

And 2016 hasn’t started any better (the rain in Sydney has been nice though – not), as fears mount about China, energy gluts, geopolitical worries everywhere and the US bull market drawing to a close – but everywhere I go, there is a growing trend for IFAs, using managed accounts, to use 100% ETFs to manage their client portfolios – this strategy, thus, relies 100% on the ICs of these groups to make correct asset allocation calls, as this is the only source of value available to them – how many great asset allocators are there, and do these models just rely on SAA with the occasional tilts or are they truly dynamic?  And if everyone is using the same forecasting models, or the same inputs from external providers, then most of these portfolios will be crowded in the same trades, which may result in poor outcomes in times of market stress (like now).

So is it time to reconsider the role of true to label active equity managers in a client’s portfolio, and if so, how might they be used to complement the ETF approach?

My not so academic definition of active management

But before we get there, first a definition of what active management is not.

I do not consider (and this is a non-academic argument), a fund manager who has low tracking error, that hold all the banks, BHP,/RIO and TLS etc, as active. It is not like they can’t see where the risks are in these stocks but they chose to adjust their portfolios only slightly in response; that’s not being active – this is simply an open ended fund’s way of remaining open to new flows, as BDMs seek to gather as many assets possible (rewards are linked to these activities), irrespective of the return impact on end investors – career risk plays a major role here for the fund managers of such funds. And unfortunately, most of the surveys that prove that active managers do not add value, include these type of funds – how can they add true alpha over time in this environment?

The rise of the absolute return managers is cause for celebration given my whinge about so called active managers

Over the past five to six years, a new group have emerged that have some important features (see below) – many are wholesale only but more and more are being offered to retail clients and are available on platforms.  Names such as LHC, Totus, Bennelong, Auscap, Wavestone and Winston manager, Monash Investors, are not afraid to deviate significantly from equity benchmarks, holding none of the standard names (potentially shorting them when it makes sense to do so), whilst also having an ability to vary the market beta to manage downside risk or be completely market neutral when it suits.  That is, these funds are managed by bright people, generally in two to three person teams, who have the ability truly express their views, using all of the tools that are now available to fund managers – they are not concerned about benchmark returns but in generating absolute returns. Equals, Active.

Features of these absolute return managers/strategies include,

  1. PMs with high IQs making more right calls than wrong over time,
  2. PM’s that simply cannot work in large institutions, although many have,
  3. Focusing on absolute returns and capital preservation and not on relative returns,
  4. Having mandate flexibility so that they can truly express their views,
  5. Capping the growth of the funds that they manage to focus on returns and not asset gathering (this feature generally comes with performance fees however),
  6. Having smaller teams with nimble decision making abilities,
  7. Not being locked into one rigid investment style, and
  8. Having the ability to hold cash, futures or by being both long and short to manage risk.

Examples of post fee 12 month returns to the end of November 2015 for some of these managers,

  1. LHC – 36.2%
  2. Bennelong Long Short – 32.8%
  3. Monash Investors – 16.6%
  4. Totus – 43.4%
  5. Auscap – 30.6%
  6. Wavestone – 14.1%

(SourceAustralian Fund Monitors)

What these numbers don’t tell you is the above managers’ gross/net exposures, the concentration of their portfolios and other such risks taken to get these results – this article is not for that.  It simply highlights that these absolute return strategies have produced very strong after fee returns in what was has been both a very flat and volatile market – all of the above had Sharpe ratios over 1.6 as a matter of interest over the past three years.  I also recognise that the above is a ridiculously, and arguably meaningless time period in which to judge a manager/strategy, but I use it to highlight what can be generated when the market returns are so weak. BTW, the three year numbers for the listed managers are also very compelling.

And by highlighting the post fees text in bold, I simply highlight that these funds are more expensive than the benchmark huggers, but investors have been well and truly compensated for the higher fee load.  Active management, can justify higher fees.

The non academic but intuitive active test for dummys (that would be me)…

To ascertain whether these new products are truly active though, it makes sense to review the top ten positions versus a standard index before worrying too much about the other features one would expect to see in this space.  It is a very rough guide but it is intuitive.  To me, if you see the same name as your ETF provider and with similar weights, it might be best that you move on.  Often, the large wealth managers launch new products to capture investor demand but their absolute return portfolios can look remarkably similar to their mainstream products – this is not a philosophy but a way to generate sales.  Avoid. The absolute return segment is currently dominated by true to label boutiques.

What role might these new funds play?

I have written extensively on the rise of ETFs over the past couple of years – I am a major supporter, notwithstanding the comments made above about asset allocation being the only source of value for those groups using them to manage their clients wealth, but if the so called active managers continue to hug their benchmarks, then they deserve to lose sales to the ETFs (hello disruption). Therefore, the new age funds, could be used to complement ETFs providing ICs with two sources of value (asset allocation (beta) and true alpha) – stock level cross ownership should be low between most of these absolute return funds and the ETFs being used, and they may act as a great risk management tool when shorting is used or when the fund is completely market neutral.

For planners wanting to give their clients exposure to growth assets but with less risk (counterintuitive given how much more flexible the mandates are), the absolute return equity funds might be a place to explore – they are active, and based on the above, are worth the fees.  Further, given that most clients have their own direct stocks (my Daddy gave me these BHP shares, and his Daddy gave them to him (said in a Southern US accent for effect) and/or to complement ETFs, these new funds will give them exposures to companies that might be flying under the radar, and/or they may be shorting some of the well known direct stocks, which together, may act as a decent diversifying tool.

2016 – the year to review and change?

If planners are worried about equity market volatility, especially so for pre-retiree and retiree clients but still want exposure to growth assets but with generally less risk, then having some exposure to absolute return managers to complement ETFs and other direct holdings might add a lot of value in time.  The research houses have taken on the challenge of covering these new managers/strategies, either as part of their Alts reviews, or as a subset of the equities review – this will assist planners make the right choices, as these strategies can be more complex to explain.

My wish from here, is that as the domestic offerings continue to grow in time, and as planners gain a greater acceptance of these strategies, that we can get similar products for global equities.

Andrew Fairweather, Founding Partner

(Obvious disclaimer – Winston represents two absolute return managers in CFM (Alternative Beta) and Monash Investors (Absolute Return Australian Shares) – hopefully my inclusion of competitors in the above article will ease anyone’s need to vent their fury in my general direction, but feel free if it makes you feel warm and fuzzy).