Nicholas Grove: Morningstar's fund research team recently released its Australian Large Companies Sector Wrap-Up. Here to share some insights into that report, I'm joined by Morningstar research manager Tom Whitelaw.
Tom thanks very much for your time today.
Tom Whitelaw: Thank you.
Grove: First of all, Tom, how many managers did you cover in the report and what sorts of changes were made?
Whitelaw: We just covered 71 strategies out of a universe of around 230; and that equates to around 80 per cent by total assets under management. So, we upgraded six strategies. We downgraded eight and we also added new coverage on nine funds. Notable changes, so Perpetual Australian Share moved from silver up to gold. So it joins Schroders, Fidelity and the two Greencape strategies on our highest medalist rating. A notable upgrade is also Perpetual Share Plus, which moved from neutral all the way to silver.
Then on the other side, we downgraded Perennial Value from silver down to neutral and we also dropped Macquarie High Conviction from neutral to negative, and interestingly, that strategy has undergone quite a few changes since that downgrade.
Grove: Tom, in the report, you talk about the active share strategies of Australian large-cap managers. For the uninitiated, can you just give us an idea about what active share means?
Whitelaw: Sure. So active share basically is a definition of how active or how different a portfolio is from the benchmark. So it's fairly simple to calculate. All we do is we take away the fund's portfolio from the benchmark portfolio and what you're left with is the active share. So, say for example, a fund's got 80 as its active share score and 80 per cent of those positions are active and are different from the benchmark.
So, an easy example would be, if you're an index fund and you hold exactly the same as benchmark, active share score is zero. But just say you don't own any CBA (Commonwealth Bank of Australia). CBA is 10 per cent of the index. So your active share is 10 - that's the difference.
Grove: Tom, does a more active manager necessarily always deliver a better return than a less active one?
Whitelaw: If only it were that simple. No. So, the active share score, what it does actually show is that the more active a manager, the more potential there is for outperformance, but also the more potential there is for underperformance. So as an investor, you can have a look and see how active your manager is being and if you're paying active fees, you want a manager that is making sufficient amounts of active bets to kind of get that payback and also beat the index. But no, if you pick a bad manager then they can underperform just as much as a good manager could outperform.
Grove: Was there anything else interesting you picked up in your active share research?
Whitelaw: Yes. So, we've been doing this research for about five years now. So we've built quite a nice history of active share scores across that time. One thing we noticed during the global financial crisis was that managers were actually reducing their activeness as markets got difficult and things were harder to predict, managers reduced activeness and they moved closer to the benchmark.
You can understand why - they are not sure what's going on, so they want to reduce their risks. But as an investor, that's the time when you've given your money to a professional and you kind of want them to be making those bets to keep you out of trouble.
What we actually noticed over the last few years is a similar form in active share scores, but perhaps for a different reason. So we obviously all know about the sell-off that we've seen in resources. So as the resources market and the mining stocks have been sold off, we've seen an increase in the valuations and the percentage of the index of the industrial side. So if you got an industrial fund or SRI/ethical fund you didn't previously own resources, so now resources have become a smaller part of the index.
So naturally, the industrials have become a bigger part, so that will become bigger parts in those industrial funds and SRI portfolios, which means their active share score is reduced. But there are instances where somebody like AMP, for example, they told us that they were just finding it difficult to find conviction in this market, therefore they have been paring the portfolio back to benchmark, while their analysts had a chance of seeing where some value lay.
Grove: Tom, one of the themes you discussed in the report is the sell-off in resources. Which managers do you believe have taken and continue to take the most prudent approach to this sector?
Whitelaw: Yeah, I mean it's pretty much been caution across the board. There are few a notable exceptions that did stay with the resources theme and did keep some of the mining stocks and the services stocks and those guys got really hurt. But like I say, caution was the name of the game and we had a lot of managers preferring to have that benchmark way to get some exposure through BHP, the large diversified miner.
Then if you were a little bit more confident they may have thrown some Rio in there - a little bit more single commodity risk and more focused on the iron-ore side, but obviously great kinds of revenues coming in from all over the place, so they can really support a falling market. And then if you are even more confident you might see some Fortescue in there as well. Much more leverage to the iron-ore price and if you're bullish on China, bullish on growth, then that was a good way to play that. But like I say, on the whole most managers that we spoke to were very cautious.
Grove: Finally Tom another thing you touch on in the report is the hunt for yield, do you believe the big cap defensives have maybe run a little bit too far?
Whitelaw: Yeah again it's these differences that make a market and on one side, we've got a number of managers who do think that these stocks are looking very expensive. So, you look at someone like Anton Tagliaferro at IML, a long-term fan of something like Telstra. But as it gets close to $5, he starts thinking that stock's looking expensive and he is taking some of it off the table.
You've got Perpetual, long-term holders of CBA, long-term overweight. They're actually underweight that stock for the first time in the last 10 years now. And we just saw a recent study that came out from UBS showing that CBA is actually the world's most expensive bank. But then you've got other managers like Dion Hershan at Goldman Sachs who will look at that study and he will say, "Well there is a reason why these stocks are the most expensive".
You look at the competitive environment and the industry structures within Australia, you've got oligopolies, monopolies, duopolies all over the place and he believes that is the reason why you have that premium and he sees more value in there. As we've spoken about before this hunt for yield is still out there - I mean the rates on term deposits have come down substantially over the last three years. Bond prices, bonds aren't really providing a great income anymore. So people look at the yields available on some of these large-cap industrials and they see them as pretty attractive still.
Grove: Tom thanks very much for your time today.
Whitelaw: Great. Thanks a lot.