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Index investing triumphs over active managers

Arian Neiron  |  07 Nov 2016Text size  Decrease  Increase  |  

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Given the lagging performance of many active strategies, it is no surprise investors are increasingly switching to passive management, VanEck Australia's Arian Neiron says.


Most Australian active funds were outperformed by their respective benchmark over one, three and five-year periods, according to the latest S&P Dow Jones SPIVA Australia Scorecard.

Scrutiny is increasingly being applied across the funds management industry as investors search for outperformance, value and transparency in an increasingly cost-conscious world.

As a result, investors are turning to passive investment options, particularly smart-beta ETFs, which provide targeted outcomes for less cost than comparable active strategies.

The latest scorecard was released this month and is based on the returns of 608 Australian equity funds (including large, mid and small caps as well as A-REITs), 294 international equity funds and 66 Australian bond funds.

The following table summarises the percentage of active funds outperformed by their benchmark across Australian equity and Australian bond funds as of 30 June 2016.

The results are more pronounced in Australian bonds and A-REIT funds, which significantly underperformed their respective benchmarks over key periods.


Percentage (%) of active funds outperformed by their index


Source: S&P Dow Jones Indices LLC, Morningstar. Data as of June 30, 2016. Table is provided for illustrative purposes. Past performance is no guarantee of future results.


Australian A-REIT funds recorded an average return of 22 per cent over the past year to 30 June 2016, lagging the S&P/ASX A-REIT Index by 2.5 per cent.

On average, 90 per cent of Australian A-REIT active fund managers underperformed the S&P/ASX 200 A-REIT Index over one, three and five-year periods.

In the Australian bond category, almost 90 per cent of funds underperformed the benchmark over one-year periods, while 92 per cent and 88 per cent of funds lagged the benchmark over three and five years, respectively.

Australian large-cap equity managers didn't perform particularly well either. Almost 60 per cent underperformed the S&P/ASX 200 Index over the 12 months to 30 June 2016, posting an average return of 0.09 per cent compared to 0.56 per cent returned by the benchmark.

Almost 70 per cent of Australian equity funds were outperformed by the benchmark over five years.

Interestingly, in a category where active management has demonstrated its superiority, over half of the Australian equity mid and small-cap funds lagged the S&P/ASX Mid-Small Index over the past one and three years.

Compared to the 30 June 2015 scorecard, the number of Australian mid and small-cap active funds that have failed to outperform has risen significantly, as shown in the following table.


Year-on-Year (%) change - Percentage (%) of funds outperformed by the index


Source: S&P Dow Jones Indices LLC, VanEck. Data as of June 30, 2016 and June 30, 2015. Table is provided for illustrative purposes. Past performance is no guarantee of future results.


ETFs provide transparent, liquid and targeted outcomes, while also providing lower management fees than comparable active funds.

The following chart shows management fees for open-ended active funds in Australia are almost three times higher than ETF management fees in the same categories.


Open-ended active management fees vs ETF management fees


Source: S&P Dow Jones Indices LLC, Morningstar. Data as of Sep 30, 2016. Index and leveraged funds are included from the open-ended funds universe. Figures are equal averages of funds' and ETFs' latest maximum management fees. Chart is provided for illustrative purposes.


Investing in smart-beta ETFs provides investors with the intersection between active and passive management.

Smart beta index strategies enable investors to achieve low-cost targeted investment exposure by actively identifying a factor or investment approach, such as quality or value, while the ETF vehicle provides the benefits of ASX trading, liquidity and transparency.

Smart-beta ETFs track smart-beta indices by holding the shares that are in the index and only change their portfolio when the index changes.

Traditionally, most ETFs followed conventional market capitalisation weighted indices, however this trend is rapidly changing with smart-beta ETFs emerging as the fastest-growing segment in the asset management industry.

In the US, growth of the smart-beta exchange-traded product market has now outpaced the growth of the broader ETP industry.

The following chart shows smart-beta ETPs represented approximately 21 per cent of all US ETPs at the end of June 2016.


Smart beta ETPs share of the overall US ETP market


Source: Morningstar Direct, Morningstar Research. Data as of 30 Jun 2016. Charts and tables are provided for illustrative purposes.


The CFA Institute recently reported that smart-beta products--by carving out a significant component of active management and offering it more cheaply and more transparently--will disrupt the business of active management.

In particular, "active management will evolve into two separate product types: smart-beta products with lower fees; and pure alpha products with higher fees1".

Given the lagging performance of the majority of active strategies, it is no surprise that investors are increasingly switching from active to passive management strategies.

At the end of September, Australia's ETP industry had reached a new record of $24 billion, with growth expected to continue.

1CFA Institute paper: The Asset Manager's Dilemma: How Smart Beta is disrupting the investment management industry by Ronald N Khan and Michael Lemmon, Jan/Feb 2016

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Arian Neiron is the managing director of VanEck Australia. VanEck is a leading global provider of exchange-traded funds (ETFs). This is a financial news article to be used for non-commercial purposes and is not intended to provide personal financial advice to any person.

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