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Is the average fund manager actually below average?

The folly of measuring returns against other managers.

Figures from Morningstar show that for the 10 years to the end of March, South Africa’s best-performing local general equity fund returned 15.63% per annum. At the other end of the scale, the worst performer returned 6.48%.

Put another way, given that inflation averaged just under 6% for this period, investors in the top-performing fund saw an annualised real return (above inflation) of close to 10%. Those in the poorest performing fund saw their real worth grow at less than 1% per year.

This is an enormous disparity. As the table below shows, R1 million invested in these two funds 10 years ago would have produced vastly different results.

Growth of R1 million over 10 years
  Annualised growth Final total
Top performing equity fund 15.63% R4.73 million
Worst performing equity fund 6.48% R1.91 million

Over five years the contrast between the best and worst performers is even more stark. For this period the range is from 9.15% in the leading unit trust to -2.71% in the weakest.

Growth of R1 million over 5 years
  Annualised growth Final total
Top performing equity fund 9.15% R1.58 million
Worst performing equity fund -2.71% R855 066

It is not, however, just the range between these two extremes that investors should consider. It is also worth looking at what happened in the middle.

Over 10 years, the total range between the best and worst performing funds was 9.15%. Yet 50% of unit trusts in this category delivered returns within 2.57% of each other, and within less than 1.4% of the category median.

This means there is a concentration of funds that perform around the average. This is illustrated in the table below.

SA equity general fund performance over 10 years
  High Low Range
1st quartile 15.63% 13.71% 1.92%
2nd quartile 13.52% 12.19% 1.33%
Category mean 11.98%    
Category median 12.15%    
3rd quartile 12.11% 10.87% 1.24%
4th quartile 10.73% 6.48% 4.25%

Source: Morningstar

A similar pattern emerges over the past five years. Over this period, 50% of funds fall within 2.51% of each other, and 1.5% of the median.

SA equity general fund performance over 5 years
  High Low Range
1st quartile 9.15% 5.71% 3.44%
2nd quartile 5.6% 4.57% 1.03%
Category mean 4.26%    
Category median 4.55%    
3rd quartile 4.53% 3.05% 1.48%
4th quartile 2.85% -2.71% 5.56%

Source: Morningstar

An animated graphic produced by Corion Capital – Equity fund outcomes over the last five years – shows that this holds true through time. The analysis covers the five-year period to the end of February 2019 and shows that the range of performance between funds in the middle two quartiles remains narrow throughout.

This is probably not particularly remarkable. When plotted on a chart, the distribution of returns would reflect a standard bell curve.

What is notable, however, is that the distribution does not fall around the market return. It is actually significantly below it.

What is average?

That much is clearly evident from the fact that all of the funds in the two middle quartiles have underperformed not only the FTSE/JSE All Share Index, but the index-tracking fund with the longest track record. As the table below shows, the Gryphon All Share Tracker Fund sits in the top quartile of performers over both five and 10 years.

Performance of Gryphon All Share Tracker Fund
  Fund Rank Category mean Category median
5 years 6.5% 15/102 4.26% 4.55%
10 years 13.8% 12/60 11.98% 12.15%

Source: Morningstar

This clearly contradicts the ill-informed view that index trackers deliver an ‘average return’. Over both five and 10 years the Gryphon All Share Tracker Fund outperformed the category average by around 2%. So if the index is considered ‘average’, then the average fund manager is decidedly below average.

It also highlights another problem, which is that many managers in South Africa use the category average as their benchmark. In other words, they are not trying to outperform the market. They are only aiming to beat their peers.

As this analysis shows, that means they are targeting below-market returns. This is a questionable approach when investors have had the option of investing in an index tracker that will, more or less, deliver performance in line with the market.

What should active managers be aiming for?

It is worth noting that of the 11 funds that outperformed the Gryphon All Share Index Tracker over the past 10 years, only one uses the category average as its benchmark. The others all measure themselves against an index, or a combination of indices.

There are of course arguments as to why JSE indices do not make good benchmarks. Mostly these have to do with how concentrated the local market is, and the impact that just a few stocks have on its performance.

However, there are ways to mitigate that. For example, a number of managers have moved to using a capped index, which limits the weighting of a single stock to 10%.

More pertinent, however, is that the market is what it is. It will never be perfect. It will always have its idiosyncrasies that managers have to navigate.

That is, however, what investors are paying them to do. There are obviously some very good managers in South Africa who have done this successfully. Regardless of how the market is made up or how it has performed, they have delivered value to investors by outperforming it.

That should be what any active manager aims to do. And it’s hard to see why any investor should be satisfied to settle for anything less when the market return is available to them through an index tracker.

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Name and shame the under performers.

They would never do that, as that sweet advertising money would dry up.

Number 1 over 10yrs – PSG Equity
Last over 10 yrs – Cannon Equity

over 5 years, Cannon Equity last again.

All publicly available info.

Please advise where one find this information on the Internet

I invested in PSG 4 years ago through a PSG advisor. My returns have been negative due to fees.

TheSpark you invested in PSG what? Equity Fund? Balanced Fund? Local or Global funds? or did you invest in PSG Group shares?

Although the myth of active management is a huge fraud perpetuated on uninformed investors, the notion that the All Share’s concentration risk (esp. regards Naspers) is simply an ‘idiosyncrasy’ that active managers need to negotiate is just as absurd. If the benchmark is inappropriate, then we should not expect active managers to view it as their benchmark. Nor should the author. This exercise would have been more valuable, using the above-mentioned capped All Share index as the benchmark.

The fact that index investors earn an above-average return (measured against the average active investors) goes to the very premise of index investing, so no surprises there. In theory, it simply reflects the cost-differential between the two approaches.

The other obvious point (seen in the above results) is that the downside risk of active management is usually far greater than the upside potential. In other words, you could do a bit better with active management (relative to index investing), or a lot worse.

Active investing presents a pay-off profile that no long-term investor should accept.

I think you might have misunderstood my point. The Alsi is not an appropriate benchmark. I have written about this before.

However, a benchmark and the market are two different things. Whatever benchmark you choose, you are still up against the market. And the market will always be what it is, Naspers and all.

Part of any active manager’s job is to negotiate that market. It’s worth noting that the top performing active managers in South Africa over the past 10 years hold no Naspers in their portfolios. So Naspers is not an excuse.

Correct in that Naspers is not an excuse. All benchmarks performed very similarly. Go look at the performances of the ALL SHARE vs. SWIX vs. CAPPED SWIX vs CAPPED ALL SHARE

It amazes me that after decades of the research having been published, people are still not familiar with capital asset pricing.
The lesson learnt is the futility of looking to expected returns of securities to anticipate performance, most often gained from historic performances.
Investors, as opposed to speculators, should take a long term view. Really long term. Ideally over generations. Invest for your grandchildren and hopefully they will invest for theirs.
With the long term view, you can look forward to the basic drivers of an investment. You needn’t worry about the daily, monthly, annual or decade long fluctuation and movement of stocks, which are haphazard.
Invest in ETF funds tracking the indices of over 500 stocks.
Avoid what is called Myopic risk aversion – short sighted aversion to loss. And contemplate why investors bother with bonds when annualised returns of equities have vastly outperformed bonds over longer than a century. It is kind of like a religion: trust the markets, and give yourself over to the market drivers and over the long term the market will truly reward you….no need for financial advisors.

Take it from someone that’s worked on both sides of the fence.
One cannot categorically rule out active fund management.
One cannot categorically rule out passive fund management.
Really bored of this active vs passive argument.

Hey Patrick, when can we evolve and progress this conversation to what is the appropriate blend between the 2 strategies?
What about an 85:15 split in favor of passive?
I base this on the percentage of active fund managers that actually outperform and those that don’t.

One cannot categorically rule out active fund management.
One cannot categorically rule out passive fund management.

Exactly.

The question is, for every R100 one has available to invest, how does one proportionally invest the R100 between active and passive portfolios.

Unfortunately it’s a far more difficult question than it appears. What is optimal for one investor is not going to be optimal for another. The blend between active and passive in a portfolio is dependent on so many factors that it really is dependent on individual needs and preferences.

And then there are the MULTI-MANAGERS who try and second guess the fund managers by creating more EFFICIENT portfolios.

Demanding a snout in the trough in return for producing surveys!

There are quite a few guides as to how active and index strategies can be blended. You have to look at the expected cost of fund management in both as well as some measures of market efficiency. You also have to make an assumption about the outperformance you expect from your active managers. For example, will they actually beat their own fees in future? Based on that you may roughly find that you would prefer index investing in very efficient markets (global equity, global fixed income) and you may want to tilt more towards active management in concentrated, neglected markets such as GEM and SA equity. But you need to be careful what you pay for active. Fees are certain, alpha is hopeful. And avoid performance fees, obviously.

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