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If you can't beat them, join them

Chris Tate  |  15 Nov 2021Text size  Decrease  Increase  |  
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A well-documented trend in recent years has been strong asset growth in passive investments and exchange-traded funds. BetaShares' September 2021 ETF Review revealed the total market cap for exchange-traded products reached an all-time high of $125 billion in Australia, or around 3% of the size of the managed fund market. In the aftermath of the Royal Commission and with the introduction of Your Future, Your Super reforms, attention has been focused on both fees and investment outcomes within the multi-asset marketplace. It is unsurprising then that we are increasingly seeing similar growth within multi-asset portfolio offerings, whether they be managed accounts, industry fund offerings, or traditional managed funds.

In Morningstar's two largest multisector categories, balanced (containing 41%-60% in growth assets) and growth (61%-80%), asset managers have introduced index strategies in part to stem outflows, as the spotlight is shone on many underperforming multimanager offerings.

The sea of negative numbers in Exhibit 1 below shows the lack of success active multisector strategies have had in maintaining assets. This is no one-off, with the data showing continued outflows across a multiyear horizon. In percentage terms for those strategies in outflows, this represents an approximate 15% to 30% decline in assets under management over a three-year period.

Exhibit 1 Net Flows of Active Managers Under Coverage in Morningstar’s Balanced and Growth Categories Over One and Three Years to 30 September 2021

(Click to enlarge)

Where are multisector investor flows headed?

There is one manager bucking the flight of assets. Its point of difference—sustainability. Investing with environmental, social, and governance considerations is a space that has undergone rapid evolution, led by the European market. As Morningstar's second-quarter 2021 Australian Sustainable Investing Landscape report alludes, though domestic supply of ESG-intentional strategies is still relatively modest compared with global counterparts, investor demand is just as strong. With limited choice, Australian Ethical Balanced 1863, a new entrant to Morningstar coverage in the 2021 review cycle, has achieved strong first-mover advantage. Its strong sustainability message has resonated with a particular cohort of investors, and over the year to 30 September 2021, assets grew in excess of 25%, contrary to almost all active multisector strategies under coverage. This strategy scores as a Leader under the Morningstar ESG Commitment Level, yet we remain unconvinced of its investment merit, as indicated by its Morningstar Analyst Rating of Neutral.

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The other active standout is industry superannuation funds—longtime beneficiaries of compulsory superannuation into default investment options via MySuper and other industry awards. But it is fair to say that less expensive fees in the active multisector space have been a big part of the lure as well. What is also striking is the gigantic totals invested in these options, led by asset-management behemoth AustralianSuper, which dwarfs all others in our multisector superannuation category.

Indexation

While the ESG thematic appeals to one market segment, it won’t come as a surprise that flows have been directed to cheaper, index-tracking strategies, utilising the same or similar base asset-allocation frameworks. There has been outsize growth in strategies that offer a passive multi-asset solution, as illustrated by the positive flow figures in Exhibit 2. The exception here is FirstChoice’s Multi-Index suite as the lone passive manager to see outflows. Investors have seemingly lost patience with the strategy, which has faced headwinds caused by a value equity style bias through its use of Realindex funds, as well as a relatively high fee. The industry super funds have also cottoned on to this trend, with AustralianSuper and Sunsuper now offering their own passive capabilities

Exhibit 2 Net Flows of Passive Managers Under Coverage in Morningstar’s Balanced and Growth Categories Over One and Three Years to 30 September 2021

(Click to enlarge)

Fees

It has long been argued that asset allocation is the main driver of investment returns in portfolios. The growth in index offerings plays to that narrative and seeks to implement these allocations via low-cost ETFs and passively managed funds. Indeed, Exhibit 3 shows that the average annual fees and costs of active multisector offerings is around 96 basis points, compared with 32 basis points for the average index option. The industry super funds, which have been low-cost leaders for some time, charge 79 basis points annually on average. Passive multi-asset options are also now offered by some super funds, with Australian Super and Sunsuper offering these options to members for 13 and 33 basis points per year, respectively.

Exhibit 3 Average Total Cost Ratio (Prospective) of Passive, Active, and Superannuation Multisector Managers in Morningstar’s Balanced and Growth Categories at 1 October 2021

(Click to enlarge)

Investors are the winner

The number of index offerings from multi-asset shops continues to expand. With the old bank-owned investment management arms now having to compete for investor dollars, retaining investors has required a change in mindset. Groups such as BT, MLC, and Colonial First State have in recent years launched their own passive offerings to compete with long-standing incumbent Vanguard, selling their value proposition as being superior asset allocation. The offerings may also include part active, part index components or variations on market-capitalisation-weighted indexes forming the investment implementation. This gives investors a far greater breadth of choice but at a fee level that provides compounding benefits over a 30-year holding period and therefore better outcomes in retirement. Further sustainable multi-asset solutions will no doubt appear, given the inflows seen by Australian Ethical providing investors with more choice to express their ethical views. Whichever way you slice it, the growth of passive investing has been good for the average investor, if not the institutions that have underdelivered, which are now adopting the mantra that if you can’t beat them, join them.

is a manager research analyst at Morningstar.

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