… as Mercer study finds NZ active mostly ‘fit for purpose’

Active management continues to be a good bet in the New Zealand equities market but the odds narrowed in recent years, a new Mercer report reveals.

According to the just-released Mercer study over the five years to the end of 2016 the median NZ shares manager beat the benchmark S&P/NZX50 by 0.5 per cent before fees and tax.

However, the latest return data palls beside the previous five-year stretch ending in December 2011 when the median NZ manager outperformed the index by 2.1 per cent (albeit in a negative return environment). During the five years to December 31, 2006, the median NZ equities shop returned 1 per cent above the benchmark.

“We can observe that the median manager has struggled to ‘earn their keep’ over the latest five-year period,” the Mercer paper says. “After fees are deducted close to half of managers may have delivered a return below benchmark, and certainly below a frequently adopted out-performance target of 2.5 per cent.”

David Scobie, Mercer NZ principal and author of the study titled ‘Chasing great: should we expect local equity managers to outperform?’, said it was difficult to discern a downward trend in the effectiveness of active local share managers as reflected in the variation between the five-year datasets.

“It doesn’t make sense to draw long-term conclusions based on recent market conditions or points in a cycle,” Scobie said. “However, if we ran through many more years where a fairly high proportion of managers were not adding material value, naturally the question starts to answer itself.”

But on another measure – rolling one-year excess returns above the index during the 15 years to end December 2016 – the average active NZ shares manager has added value “over a reasonable proportion of time periods, including after allowing for active management fees”, the Mercer report says.

The study found upper quartile managers significantly beat the benchmark “over almost all periods” while lower quartile funds struggled to keep their heads above the index “with any consistency”.

“The outcomes tell us that a typical out-performance target in the order of 2.5 per cent per annum has been ambitious in recent years albeit that, over the long-term, such a margin is a reasonable expectation to justify an active approach,” the paper says.

Mercer notes the idiosyncratic nature of the NZ share market does, in theory, lend itself to active management. The report says clued-up local fund managers can outperform at the expense of less-informed investors – including income-seeking ‘mums and dads’ as well as liquidity-focused offshore funds (often via index-tracking strategies).

Furthermore, the report says astute fund managers can exploit information gaps in the relatively lightly-researched NZ stocks outside the top 20. NZX stocks also tend to be less-correlated than some offshore markets, the report says.

“This is positive from an active management perspective because it means prices are reacting more to company-specific information than macro or political developments…,” the paper says.

Nonetheless, the report notes the easy pickings on offer for active managers by betting on a handful of large companies have diminished now as “capitalisation is more dispersed”. The Mercer paper also says while many NZ equity funds have spiced up their portfolios with Australian stocks, the practice has not been “a heavy driver of alpha for the median manager”.

Scobie said the influx of new money into the NZ share market from KiwiSaver schemes and Crown financial institutions (notably the NZ Super and ACC funds) has also changed investment dynamics.

“There is this ‘demand pressure’ in terms of money to potentially be put to work, but every fund manager has a choice as to whether to take it on, and determining whether doing so would compromise their ability to meet their performance objectives. Some providers have diverted assets offshore to a greater extent than they might have otherwise,” he said.

“We can acknowledge a KiwiSaver effect – and on the supply side can note that the NZX has not exactly flourished in terms of consistent new listings – but that does not justify a scenario where an investor is paying an active management fee but may not be getting a return above benchmark which reflects that (over the medium-long term).”

Overall, Mercer says “active management within NZ equities is worth considering by most investors”.

“This is not a ‘slam dunk’ finding and we note that the case is most strong where investors are well placed to select the better-performing fund managers,” the paper says.

Implementation problems as well as the lack of “cost-effective options” for passive NZ shares also bolsters the attractiveness of active management, Mercer says.

“By international standards, the scope for passive fees to fall is readily apparent,” the report says.

– Investment News NZ