Your Actively Managed Superannuation Fund Cannot Beat the Market

While housing bulls gnash their teeth over that one, what about shares? They were down again Friday in New York. The Dow Jones Industrials fell another 2.7%. All those green shoots are getting eaten by the Black Swan of deleveraging.

Here is a more worrisome note, though: you can’t beat the market. Or at least, your actively managed superannuation fund cannot beat the market. That is the conclusion of two researchers from the Australian Prudential Regulation Authority (APRA). This is probably unwelcome news from those in the actively-managed superannuation funds business.

“On average,” researchers Wilson Sy and Kevin Liu conclude,” value adding from active management appears statistically to be unable to overcome higher costs associated with attempts to exploit market inefficiencies…Higher management expenses leads to poorer net investment performance of the firms.”

There are at least two points worth noting in this survey, three actually. First, actively managed funds, on average, don’t beat the market. Unless you know a genius manager, paying for results doesn’t deliver them. Second, the underperformance (by about 0.9%) is directly attributed to the fees you pay. If you invested in a passively-managed index tracking fund, you would do just as well as the market, and not pay a cent.

But the most incriminating finding from the study is that active managers do worse in a bear market! That shouldn’t be too surprising, really. Fund managers are paid to be in the market, not to be in cash. This is true even when you are better switching to a super option more heavily weighted in cash. Cash does not generation commissions!

To be fair, the study showed that half of the 115 superannuation funds beat the benchmark index (with the best fund doing 18% better). But the big question this study prompts is whether-by correctly making a few key decisions-a self-managed super investors can regularly do better than actively managed funds AND benchmark indices.

Beating most actively managed funds shouldn’t be hard, we’d humbly suggest. They outperformance the index anyway, when you figure in management fees. And because the funds show a bias to shares, (these funds allocate 50% of assets to Aussie and international shares), they are likely to get clobbered when asset allocation models suggest you ought to shift to cash, fixed income, or (ahem), property.

Of course the truth of the matter is that being in the right asset class at the right time is the single-biggest determinant to how well you do as an investor. That is, you don’t have to be Warren Buffet to beat the market. You just have to be in the right market at the right time. Stock selection, as much as it is touted by value investors, is simply less important than whether or not stocks as an asset class are rising.

You don’t have to be a highly paid fund manager to know whether stocks are in a primary bull market. In fact, the fund managers are likely to get it wrong because they would prefer stocks to be in a bull market. It makes the job of index tracking and fee collection much easier. But the real challenge is correctly interpreting those inflection points in the market where one asset class falls out of favour (peaks out) and another, previously ignored or cheap asset (kudos to the value crew) enters into a bull market.

Those are the tough spots to pick. But we wonder why a professional fund manager is any better equipped to call those market tipping points than a well-informed self-managed super investor who cares more about his money than generating fee income. In fact, a well-informed investor who accumulates a variety of different perspectives and then reconciles that information with his own preferences, risk appetite, and judgment is just as likely to get the big calls right as anyone else. Probably more likely, considering he doesn’t have any bias toward a particular asset class.

If you want to read the whole study, go here. For now, we’ll quote two important pieces of it that show that making basic decisions about how you allocate your assets is the single-biggest factor in determining the performance of your super fund.

“It is seen that 38.5% to 66.7% of the cross-sectional annual returns of our dataset are explained by their benchmark asset allocations, depending on the period and depending on whether the comparison is gross or net of costs. Over the whole five-period, the cancellation of short-term noise leads to an R-squared of more than 95%. Our results are consistent with expectations from earlier research (Brinson et al., 1986, 1991; Ibbotson and Kaplan, 2000).

You read that right. Your super returns are determined by being in the right place at the right time. This is the quiet little secret of great investment returns. Getting them may be hard. But it’s not impossible. But why is it true?

“These results have very simple explanations. It is clear that the greater are the differences in returns to different asset classes, the more asset allocation explains performance. Over the short-term, the asset return differences may be insignificant and may be swamped by other short-term effects of active management; asset return differences explain less of the cross-sectional variability. Asset allocation explains more of time variability because over time the differences in returns of different asset classes become more statistically significant.”

Over the short-term, property and fixed income may look safer and better than precious metals and cash. But if bonds are in long-term bear market, if we are in a Credit Depression, and if fiat money is entering a permanent period of decline, then getting your asset allocation right now has never been more important. Perhaps, according to the reader below, you should consider cattle.

–Hi folks – enjoy the DR. Current topic is moot … what is real wealth? Just one version of the answer – the age-old definition – comes from no other authority than the Bible:

“LANDS AND CATTLE”

No desire to get into religion in any form – please – but this is an interesting concept of what real wealth is, n’est ce pas?

Kind regards

Ivan B.

QLD

Dan Denning
for The Daily Reckoning Australia

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