Wednesday, 26 September 2012

Picking Out Actively Managed Funds that Predictably Outperform

There is an oft-repeated rule of thumb that past performance is no guide to future performance, that picking funds with recent above-average results usually leads to disappointment because their future performance tends to under-perform and revert to the mean. It certainly seems to be true in Canada (e.g. Richard Deaves in the book What Kind of Investor Are You? says there is no historical evidence of persistence in either under- or out-performance). Is that situation necessarily inevitable and immutable?

Along comes Super Fund Performance, a report from the Australian superannuation industry, to say "yes, it is possible to identify with considerable confidence which funds will continue to out- or under-perform". The key differentiator: whether the funds are retail for-profit offerings or not-for-profit (sponsored by public sector, corporate or industry). Not-for-profit has been winning, and by a huge amount - an average of 2% per year for the past 15 years!

Below is a fascinating chart from the study. Especially interesting is that the not-for-profits always did better than the retail for-profit funds. It looks like a sure-fire way for Australians to narrow down retirement fund selection. Too bad the not-for-profit option doesn't exist in Canada and it doesn't look like pension reform via the government's PRPP proposal will change that soon.....

Why the out-performance?
  • lower fees/costs - the report doesn't state the difference but a quick search in one comparison website, the Canstar Superannuation Star Ratings, shows MER ranges from about 0.4% at the very low end to 2.5% at the extreme high end. The big not-for-profit funds look to be in the 0.6-0.8% Total Expense Ratio range according to another comparison site, Selecting Super.
  • economies of scale, but only among the not-for-profit funds; retail funds don't get any more efficient with size, which the report says is due to governance factors - "... either economies of scale are not available to retail funds, or the benefits are not passed on to members". 
  • embedded advice - the for-profit riposte is that their members get financial planning advice much more than clients of the not-for-profits, about twice as often according to Canstar. Investor Daily reporter Wouter Klijin says the not-for-profits are increasingly gearing up to provide advice, which he says will increase their costs and possibly/probably lessen their out-performance down the road. A big question is, of course, how useful the advice is, whether it is merely sales or client-interest-first, depending on the source. From which type of outfit would I want "advice"? That's a pretty easy call I'd say. 
Why Does Mutual Fund Performance not Persist? by Wolfgang Bessler, David Blake, Peter Lückoff and Ian Tonks provides another take on persistence using US data -
  • Winner funds keep winning if, a) the fund investment manager stays on and b) there is NOT high fund inflow
  • Losers start doing a lot better if, a) the investment fund manager is sacked and, b) there is a high fund outflow
The problem for the investor is of course, that what works on average may not happen for the specific fund selected. 


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