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IMPLICATIONS FOR INVESTORS OF SIGNIFICANT CHANGES EFFECTING THE SA INVESTMENT LANDSCAPE
March 2016John Gilchrist
“THE ASSET MANAGER HAS NO CLOTHES!”
“THE ASSET MANAGER HAS NO CLOTHES!”
Source: https://www.youtube.com/watch?v=dSWVXNtI0SU |Kim Parkhurst2
AGENDA
Introduction The Global Experience The SA Experience Why do people still choose active managers? How are investors reacting to these changes? What should you do?
3
INTRODUCTION
THE EMPEROR’S NEW CLOTHESHANS CHRISTIAN ANDERSEN (APRIL 1837)
Source: https://www.youtube.com/watch?v=dSWVXNtI0SU |Kim Parkhurst5
THE ASSET MANAGER HAS NO CLOTHES!
■ Globally active equity asset managers’ under-performance has led to a significant increase in indexation investing
■ In SA active equity managers (fundamental stock-pickers) have generally performed better than their offshore counterparts, and have used this (plus huge marketing budgets) to create a stranglehold on the market
■ Over the last 10 years, performance by most active equity managers has been poor; the last 5 years has been extremely poor – belief in these managers has been shaken
■ Regulatory changes & cost pressures are simultaneously driving many investors away from active equity managers:
− Retail Distribution Review – greater cost transparency− Proposed changes to default retirements funds - preference for indexation investing
■ We examine the implications for investors of this significant & ongoing change in the SA investment landscape
6
THE GLOBAL EXPERIENCE
PERFORMANCE OF U.S. EQUITY MANAGERSCONSISTENT & SIGNIFICANT UNDER-PERFORMANCE, EVEN BEFORE FEES
12 Months 3 Years 5 Years 10 Years0%
2%
4%
6%
8%
10%
12%
14%
Annual average return: Index Funds vs Non Index FundsUS Non Indexation FundsUS Indexation Funds
Retu
rn (
annu
alis
ed)
Source: Bloomberg (net of fees)8
PERFORMANCE OF U.S. EQUITY MANAGERSCONSISTENT & SIGNIFICANT UNDER-PERFORMANCE, EVEN BEFORE FEES
Source: SPIVA US Scorecard – mid year 20159
SIGNIFICANT GROWTH IN INDEXATION STRATEGIES
In-dex-ation17%
Non In-
dex-ation83%
Aug 2010
Source: Bloomberg
In-dexa-tion23%
Non In-
dexa-tion77%
Aug 2015
■ Indexation / passive investing has continued to grow across the world
10
SOURCES OF ALPHARESEARCH IS DEMYSTIFYING ALPHA & REVEALING MUCH OF IT IS DUE TO FACTOR EXPOSURE
Smart Beta
Re-defining alpha:
Equities: Consistent Biases
Source: Eugene Fama and Kenneth French, The Cross Section of Expected Stock Returns, Journal of Finance, June 1992; Mark Carhart, On Persistence of Mutual Fund Performance, Journal of Finance, March 1997; Robert Novy-Marx, The Other Side of Value: The Gross Profitability Premium, Journal of Financial Economics, April 2013.
Robert Novy-Marx
Indexation
Equities: Adaptive Biases
Hedge funds &
11
ACCESSING SOURCES OF EXCESS RETURN
Dec-74Jul-
76Feb
-78Se
p-79Apr-
81Nov-
82Jun
-84Jan
-86Aug
-87Mar-
89Oct-
90
May-92Dec-
93Jul-
95Feb
-97Se
p-98Apr-
00Nov-
01Jun
-03Jan
-05Aug
-06Mar-
08Oct-
09
May-11Dec-
12Jul-
140
2000
4000
6000
8000
10000
12000
14000
16000
18000
20000
USA GROWTH USA RISK WEIGHTED USA VALUE USA
■ Ability to capture sources of excess return (including value, momentum, size & quality) through lower cost smart beta strategies has been welcomed by the market
MSCI Factor returns
12
ACCESSING SOURCES OF EXCESS RETURN■ Similar to indexation, smart beta has grown substantially over the last 5 years in
particular
Global assets in smart beta strategies
Source: Morningstar Direct, Morningstar Research13
THE SA EXPERIENCE
PERFORMANCE OF SA EQUITY MANAGERS
Source: Morningstar, Old Mutual Investment Group
■ Average equity fund has lagged the index by 2.4% pa over the last 10 years
15
Feb-06Jul-
06Dec-
06
May-07Oct-
07Mar-
08Aug
-08Jan
-09Jun
-09Nov-
09Apr-
10Se
p-10Feb
-11Jul-11Dec-
11
May-12Oct-
12Mar-
13Aug
-13Jan
-14Jun
-14Nov-
14Apr-
15Se
p-15Feb
-160
50100150200250300350400450
13.7% p.a.
11.3% p.a.
JSE SWIX Index(ASISA) South African EQ General Peer Average
Cum
ulat
ive
Retu
rn
PERFORMANCE OF SA EQUITY MANAGERS
Source: Morningstar, Old Mutual Investment Group
■ The bulk of active equity managers consistently under-perform the index
16
2007 2008 2009 2010 2011 2012 2013 2014 20150%
10%20%30%40%50%60%70%80%90%
100%
45% 38% 34%26%
42%
14%
55%
17%
48%
55% 62% 66%74%
58%
86%
45%
83%
52%
1 Year Return Periods - SWIX relative to General Equity Peers
% of Managers outperforming SWIX % of Managers underperforming SWIX
PERFORMANCE OF SA EQUITY MANAGERS
Source: Alexander Forbes survey data – January 201617
PERFORMANCE OF SA EQUITY MANAGERS■ Does this under-performance really surprise anyone?
− Fundamental equity performance is driven by correctly predicting currency moves & commodity price moves & interest rate moves & political moves & central bank actions & random events & group behaviour & … simultaneously & on an ongoing basis
Source: http://richtopia.com/guidance-opinions/throw-out-your-crystal-ball18
“STATE OF SA ACTIVE EQUITY MARKET”
Source: https://www.youtube.com/watch?v=dSWVXNtI0SU |Kim Parkhurst19
GROWTH IN SA INDEXATION EQUITY STRATEGIESAu
g-05
Nov-
05Ja
n-06
Mar-0
6Ju
n-06
Aug-
06Oc
t-06
Jan-
07Ma
r-07
May-
07Au
g-07
Oct-0
7De
c-07
Feb-
08Ma
y-08
Jul-0
8Se
p-08
Dec-
08Fe
b-09
Apr-0
9Ju
l-09
Sep-
09No
v-09
Jan-
10Ap
r-10
Jun-
10Au
g-10
Nov-
10Ja
n-11
Mar-1
1Ju
n-11
Aug-
11Oc
t-11
Dec-
11Ma
r-12
May-
12Ju
l-12
Oct-1
2De
c-12
Feb-
13Ma
y-13
Jul-1
3Se
p-13
Nov-
13Fe
b-14
Apr-1
4Ju
n-14
Sep-
14No
v-14
Jan-
15Ap
r-15
Jun-
15Au
g-15
0
1000
2000
3000
4000
5000
6000
7000
8000Cumulative Growth in unit trust assets
Indexation FundsNon Indexation Funds
Approximately 51% pa growth in indexation funds
Source: Morningstar
■ Percentage growth in indexation assets over the last10 years has been impressive
20
GROWTH IN SA INDEXATION – CLOSING THE GAP
98.99%
1.01%
Unit trusts: Indexation vs Non IndexationAug 2015
Non Indexation FundsIndexation Funds
76.7%
23.3%
Unit trusts: Indexation vs Non IndexationAug 2020
Non Indexation FundsIndexation Funds
An 80% p.a. increase in the size of passive investments would result in the following
split by Aug 2020
Source: Morningstar
■ Despite significant growth (off a very low base), SA usage of indexation investing lags the rest of the world dramatically
21
WHY DO PEOPLE STILL CHOOSE ACTIVE MANAGERS?
“BEHAVIOURAL BIASES DISTORT OUR PERCEPTION OF REALITY”
Source: https://www.youtube.com/watch?v=dSWVXNtI0SU |Kim Parkhurst23
INVESTORS’ 10 MOST COMMON BEHAVIOURAL BIASES■ Confirmation bias■ Optimism bias■ Loss aversion■ Self-serving bias■ Planning fallacy■ Choice paralysis■ Recency bias■ Herding■ Preference for stories over analysis
Source: https://rpseawright.wordpress.com/2012/07/16/investors-10-most-common-behavioral-biases/
Behavioural biases that support investing with fundamental equity managers (even though data shows they under-perform on average) rather than indexation funds
24
EXAMPLE: BEHAVIOURAL BIAS
Who believes they are a worse than average driver?
25
CAN INVESTORS’ SUCCESSFULLY PICK ACTIVE MANAGERS? ■ Once again, the behavioural biases come into play when choosing which fundamental
managers to invest with, but the following biases are key:− Recency bias− Herding − Preference for stories over analysis
■ Money flows to managers with the best stories / marketing who have performed well recently & who other people are investing in
■ Let’s examine the impact of choosing fundamental managers in this way …
26
RECENCY BIAS – PERSISTENCY OF PERFORMANCE■ While studies agree that active funds under-perform indices by a significant margin,
results on the persistence of performance are less clear cut …
■ Long term winners can become medium & short term losers
Source: OMIG, unit trust performance data – September 2015
Fund 1 year 3 years 5 years 10 yearsQuartile Quartile Quartile Quartile
ABSA Select Equity 3 3 3 1Allan Gray Equity A 3 2 2 1Coronation Equity R 3 1 1 1Coronation Top 20 A 4 3 2 1Foord Equity R 2 1 1 1Investec Active Quants A 3 2 2 1Marriott Dividend Growth R 1 2 1 1Nedgroup Inv Value R 2 3 3 1Old Mutual Investors R 1 1 1 1Old Mutual Managed Alpha Equity A 1 1 1 1Prudential Dividend Maximiser A 3 2 2 1Prudential Equity A 3 2 1 1SIM General Equity R 2 1 1 1
27
RECENCY BIAS – PERSISTENCY OF PERFORMANCE■ The market environment constantly changes & manager style drift over time can occur,
distorting any meaningful analysis on persistency …
■ 3-year data appears to show some persistence, but 5-year data is inconclusive
Source: OMIG unit trust performance data – September 2015
3 Year 3 YearQuartile Quartile
Today 3 years agoABSA Select Equity 3 1Coronation Equity R 1 1Coronation Top 20 A 3 1FG IP Mercury Equity FoF A1 3 1Foord Equity R 1 1Gryphon All Share Tracker 2 1Harvard House BCI Equity 1 1Imara MET Equity 1 1Investec Active Quants A 2 1Marriott Dividend Growth R 2 1Momentum Best Blend Specialist Eq A 1 1Nedgroup Inv Value R 3 1Old Mutual Managed Alpha Equity A 1 1Prime General Equity B 1 1Prudential Equity A 2 1Sasfin MET Equity A 1 1STANLIB Equity R 2 1STANLIB MM All Stars Eq FoF B1 2 1STANLIB SA Equity R 3 1Stewart MET Macro Equity FoF A 2 1
5 Year 5 YearQuartile Quartile
Today 5 years agoABSA Select Equity 3 1Allan Gray Equity A 2 1Coronation Equity R 1 1Coronation Top 20 A 2 1Flagship IP Equity A1 4 1Foord Equity R 1 1Investec Value R 4 1Kagiso Equity Alpha 3 1Nedgroup Inv Value R 3 1Prudential Dividend Maximiser A 2 1Prudential Equity A 1 1SIM General Equity R 1 1SIM Value R 3 1
28
HERDING ■ We know that significant flows can positively impact active managers’ performance
− These flows can create an under-pin to the share prices of the managers’ favourite / overweight shares
− This is possibly a contributing factor to inconclusive persistency data
■ Successful strategies (& related share picks) are also sometimes copied by competitors, creating further support
■ However, as assets under management increase, the ability to generate excess returns declines:
Portfolio Size (R’ billions)
# of shares which can be
held10 15725 13550 103
100 80200 57
Source: Old Mutual Investment Group, Peregrine – max 5% of a share & minimum holding 0.5% of portfolio
This naturally results in manager style drift as assets increase
29
HERDINGVICTIM OF SUCCESS – ALLAN GRAY
Source: Morningstar30
Feb-07
Jul-07Dec-
07
May-08
Oct-08Mar-
09
Aug-09Jan
-10Jun
-10
Nov-10
Apr-11Sep
-11Fe
b-12Jul-1
2Dec-
12
May-13
Oct-13Mar-
14
Aug-14Jan
-15Jun-15
Nov-15
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
R 0
R 5,000
R 10,000
R 15,000
R 20,000
R 25,000
R 30,000
R 35,000
R 40,000
R 45,000
R 50,000
Allan Gray Equity A (CIS) vs JSE All Share Index
1 Year Rolling Alpha AUM
1 Ye
ar R
ollin
g A
lpha
Ran
d (m
illio
ns)
HERDINGVICTIM OF SUCCESS – ALLAN GRAY (CONTINUED)
Source: Morningstar31
Feb-07
Jul-07Dec-
07
May-08
Oct-08Mar-
09
Aug-09Jan
-10Jun-10
Nov-10
Apr-11Sep
-11Fe
b-12Jul
-12Dec-
12
May-13
Oct-13Mar-
14
Aug-14
Jan-15
Jun-15
Nov-15
0%
2%
4%
6%
8%
10%
12%
14%
16%
R 0
R 5,000
R 10,000
R 15,000
R 20,000
R 25,000
R 30,000
R 35,000
R 40,000
R 45,000
R 50,000
Allan Gray A (CIS) vs JSE All Share Index
1 Year Rolling Tracking Error AUM
Trac
king
Err
or
Ran
d (m
illio
ns)
HERDINGFUTURE VICTIM OF SUCCESS – CORONATION?
Source: Morningstar32
Feb-07Jul-
07Dec-
07
May-08Oct-
08Mar-
09Aug
-09Jan
-10Jun
-10Nov-
10Apr-
11Se
p-11Feb
-12Jul-12Dec-
12
May-13Oct-
13Mar-
14Aug
-14Jan
-15Jun
-15Nov-
15-15%
-10%
-5%
0%
5%
10%
15%
20%
R 0
R 1,000
R 2,000
R 3,000
R 4,000
R 5,000
R 6,000
R 7,000
R 8,000
R 9,000
Coronation Equity R (CIS) vs JSE All Share Index1 Year Rolling AlphaAUM
Alph
a
Rand
(m
illio
ns)
PREFERENCE FOR STORIES OVER ANALYSIS
■ Fundamental managers tell great stories, both ito the macro picture & when it comes to individual shares
■ Certain types of stories resonate with certain investors / consultants■ We have seen this result in disastrous over-concentration of investments with
managers who adopt the same investing style − Over-concentration with value investors over the last 5 years is a classic example
■ Fundamental managers also like to use fear to support their arguments, painting indexation or smart beta strategies as “ships without a captain, unable to steer away from rocks”
− Long term return number show that this argument is not valid− African Bank shows how ships with captains still end up on the rocks
33
HOW ARE INVESTORS REACTING TO THESE CHANGES?
HOW ARE INVESTORS REACTING TO THESE CHANGES?■ Increased indexation investing:
− Investors are using indexation investing as a core portfolio within a Core-Satellite approach− This should be true even if investors only use Balanced Funds
■ Increased Smart Beta investing:− Investors want out-performance, but also want value for money
■ Greater demands being placed on asset managers:− Display a clear competitive advantage− Be unique & provide diversification− Customised Solutions− Risk Management
■ Increased use of alternatives (to provide unique sources of return)
35
WHAT SHOULD YOU DO?
“SELF REFLECTION IS REQUIRED BY THE INDUSTRY”■ This is true for investors, asset managers & consultants
Source: https://www.youtube.com/watch?v=dSWVXNtI0SU |Kim Parkhurst37
WHAT SHOULD YOU DO?■ Recognise that, even though behavioural biases support the status quo, the
changes are happening fast
■ Ensure that you are fully equipped to understand the implications of these changes: We have done numerous educational sessions on:
− indexation investing;
− smart beta investing;
− risk management; &
− alternatives;
We also create customised solutions across the investment spectrum for large clients
38
39
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