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Lessons from the scoreboard

Date: Oct 15th, 2015

There are many lessons investors can garner from the sporting world. Keeping score is certainly one. Accountability is another.

When it comes to keeping score account balances and performance return figures are both useful measures of either progress or setback.

In the funds management world probably the most widely used way of keeping score is to see how a fund manager is going against their target index or benchmark.

Typically actively managed funds will set an investment objective of outperforming a target benchmark over a certain time period and that is what you are asked to pay higher fees for.

S&P Dow Jones Indices has been the de facto scorekeeper of how active fund managers perform versus respective market indexes since they published the first US SPIVA scorecard back in 2002. S&P now publishes SPIVA scorecards in 10 regions around the world – including Australia.

The report shows investors how Australian actively managed funds have performed against their respective benchmark indices over one, three and five years. In the US they also now publish 10 year results.

The results of the 2015 mid-year SPIVA scorecard for Australia that covered 599 Australian equity funds, 277 international equity funds and 68 bond funds do not make happy reading for active fund investors.

“As of June 2015, the majority of Australian funds in all categories, except Australian mid- and small-cap funds, were outperformed by the respective index benchmark over the one, three and five-year periods. International equity and Australian bond funds had the highest portion of funds underperforming their respective benchmark indices,” according to the SPIVA research report.

The headline performance numbers produced in the SPIVA reports come from a comprehensive data set that takes into account a range of technical factors including survivorship bias and also provides asset-weighted returns to better understand how the average Australian dollar invested performed.

Over one-year performance figures S&P reports that there is no consistent trend but over five years more than 70 per cent of funds in the general Australian equity category failed to beat their benchmark.

On the international equity front funds investors probably had less cause to grumble as the average international equity fund posted a strong return in the one-year period to June 30, 2015 of 23.4 per cent. But while the headline return number was strong the majority of funds (67 per cent) underperformed the comparable S&P index which returned 25.5 per cent for the same time period.

Last month S&P’s Global Research team published a SPIVA report covering the various markets where the research is done around the world. It covers 10 different markets including the US, Canada, Europe and developing markets like Chile, Brazil and India.

The time period for this work was up to December 31, 2014 but the results were broadly consistent with 89 per cent of US managers over five years underperforming the index compared to 80 per cent in Canada, 81 per cent in Mexico and 82 per cent in Europe. Developing markets like India and Brazil were two areas where active managers did better.

The index versus active debate is a contentious one and while the SPIVA reports help inform it they are unlikely to end the debate any time soon.

Vanguard is well-known as an index manager so the longer term results are not surprising. However, Vanguard also offers actively managed funds in the US and believes there is a role for both approaches. It is a matter of how you blend the two together rather than it being an either/or debate.

What is clear – and the SPIVA reports underline it – is just how hard it is for active managers to outperform particularly when you take a reasonable time horizon like three, five or 10 years.

For investors of course the challenge is finding the funds that are in the minority that do outperform over the long term.

Here the SPIVA Cross-Country comparison report is helpful in identifying one of the biggest reasons active managers underperform their indexes – high costs.

S&P have looked at average active and passive fees across a range of markets. In the US, for example, the report cites average expense ratios for active funds of 1.13 per cent compared to passive funds of 0.37 per cent. In Europe active fees are 1.88 per cent compared to 0.34 per cent for passive funds.

The report then models the impact of the fee differential – somewhere between 2 per cent to 9 per cent depending on which country you look at – over five years.

That is the amount an active manager would have to outperform on a cumulative five-year basis in order to have comparable after fees performance with a passive manager, according to the SPIVA report.

Perhaps the debate should not be focused on investing in an active way versus indexing and more attention paid to why high fees are more likely to have you on the losing team.

Written by Robin Bowerman, Principal, Market Strategy and Communications at Vanguard Australia.


Reproduced with permission of Vanguard Investments Australia Ltd

Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients’ circumstances into account when preparing this material so it may not be applicable to the particular situation you are considering. You should consider your circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This material was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.

© 2015 Vanguard Investments Australia Ltd. All rights reserved.

Any information provided by Vanguard Investments Australia Ltd detailed above is separate and external to us and our Licensee, AMP Financial Planning Pty Limited. Neither we, nor AMP Financial Planning Pty Limited take any responsibility for their action or any service they provide.

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