Ron Liling, one of the founders of Intech Financial Services, was offered the investment consulting part of his former business a couple of years after he’d sold it to Skandia. If he’d bought it back, he says, he would have changed it to a strategy consulting firm. “Picking managers is a mug’s game,” Liling said a few years ago. It seems managers are starting to agree with him.
Asset consultants, like the managers themselves, believe they have the skill to make a difference in their selections. Liling’s admission says a lot. It is true that one should beware of averages but the evidence is compelling that the average active manager has not added much, or any, value, after fees, for a long time.
In a practical sense this means that the average retiree is likely to lose all of his or her capital in the drawdown phase a lot more quickly than he or she would expect.
Work by State Street Global Advisors (SSgA), using a Monte Carlo simulation over the 30 years to December 31, 2012, shows that both the average manager and the average super fund was unable to keep up with a typical drawdown of 8 per cent a year in retirement. That is, if you retired with $1 million and took out 8 per cent a year over 30 years, you end up with minus $609,081, assuming the median balanced growth fund performance during that time.
In international equities in the three years to December last, the median manager in the Mercer survey outperformed the index by just 0.4 per cent before fees. The median Aussie equities manager outperformed the S&P/ASX 300 by only 0.1 per cent before fees in the same time.
In a series of presentations, to launch pooled fund versions of the SSgA low-volatility alpha strategies for international and domestic shares last week, Lochiel Crafter, head of investments for Asia-Pacific, said there was too much focus on relative risk and return.
Crafter, who has also had a stint running a big super fund, the former ARIA (now CSC), in his career, said that if you want to build better portfolios, you should not start with the benchmark. If you want to have a better-balanced portfolio, also, you need to manage your equity risk. Equity risk accounts for 95 per cent of a portfolio’s total risk.
Building a better portfolio is about structure rather than skill, he says. “It’s building portfolios for THE future, not A future.”
He probably agrees with Liling. Crafter says: “It’s a tough game to be an active manager or to pick one.” He says there are three key inefficiencies:
. Redundancy – on average, you end up with index-like performance if you have more than one manager
. Managers tend to buy and sell from each other
. Everyone hugs the benchmark – benchmarks shackle performance.
If a fund wants to load up on risk, a more efficient way to do it is to leverage an exposure. Managers with lower volatility, tend to have a higher chance of outperformance.
“This indicates that there is something in managing volatility,” Crafter says.
SSgA’s low-volatility strategies are not brand new. The International version has been running for big pension funds for more than four years and the Australian version for about three-and-a-half years. The new pooled-fund versions will be available for retail and institutional platforms.
Marc Reinganum, global head of active developed equities for SSgA, says that the SSgA managed volatility strategy is likely to underperform only when there is a very sharp beta rally “or junk stock rally” across the market. Over a market cycle it will have a higher return with between 35-35 per cent lower risk.
“We only hold companies we like: quality business models exhibiting growth potential, attractive valuations, strong cash flows, positive sentiment and sustainable dividends.”
The strategy is not mechanical, he says. It will not buy low-volatility stocks at any price.
SSgA has a value-based approach to currency, which has meant a very low hedge in recent times as most analysts believe the $A to be overvalued.
In highly concentrated markets, such as Australia – where about 75 per cent of capitalization is in financials and resources – the strategy will work very well because there is more to be gained by doing away with the benchmark.
The firm has about $US30 billion in its active strategies around the world.
FOOTNOTE: John Schaffer, Liling’s co-founder at Intech, disagrees with his old friend and former colleague. Schaffer, who now represents international equities boutique, Johnston Asset Management, says: “Manager selection a mug’s game? Might have been once, but Liling’s left the room…” On a more serious note, he says: “The problem’s not whether there are gun managers – there’s real alpha generating talent out there for sure – the problem lies in techniques in identifying them with confidence. They’re evolving and they will become much sharper, particularly in relation to managers who don’t manage to a tracking error. I honestly believe there will be profound changes in the next five years.”
