As a new financial year gets underway in Australia, the media tends to be full of outlooks about what investors can expect for the coming 12 months. These pieces are often entertaining to read, but can be even more so a year later.

Many Happy Returns

Hillary or Donald?  Should investors be making adjustments to portfolios based on their view of the upcoming election?  If history is any guide, you would be better served switching off the noise and focussing on the long term strategy.

In his latest Outside the Flags article, Jim Parker from Dimensional Fund Advisors looks back at some of the individual company share forecasts made at the end of 2014. 

December 14, 2015

Aside from reports on shark attacks and cricket, the onset of the festive season and summer in Australia and New Zealand are traditionally lean times in the news business. So the forecasters come out to play.

Thinly staffed newsrooms and the prospect of lots of blank space to fill over the holidays prompt hard-pressed editors to assign reporters to crank out "Year Ahead" features before they go on leave.

For readers of the finance pages, this means lots of surveys about the outlook for the economy and markets in the coming 12 months. These can be diverting at the time, but they're much more entertaining a year later.

In its 'Top 100 Picks for Investing in 2015', published between Christmas and New Year, 'The Weekend Australian' newspaper canvassed staff and contributors for their recommendations on stocks to buy.

In its heavyweights list ("energised to move"), the paper selected BHP Billiton. It was energised all right, but the movement was all down. By early December, BHP had delivered a negative return of more than 30%.

The other chosen heavyweight was Alumina, which was picked because of expectations of improved prices and returns. Unfortunately not, as it turned out. Alumina was down nearly 27% over the year.

In the oil and gas sector, the newspaper asked "have prices hit bottom?" Clearly not, because four of its five favoured picks (AWE, Otto Energy, Origin Energy and Carnarvon Petroleum) were 30-55% lower. The fifth, Woodside Petroleum was a mere 6% lower.

Never mind, the paper said. Lower petrol prices would leave people more to spend. So it favoured consumer stocks Thorn Group and Carsales.com. The latter managed a 3% gain for the year, but Thorn was down 27%.

In financials, the newspaper said Treasury Group (later Pacific Current Group) was "fuelled to fly". Its stock delivered a negative return of 33% year-to-date. Gold stocks were "ready to rise"—like Independence Group (-40%). And watch out for the "rising stars"—like Colorpak (-18%), Nearmap (-44%) and Retail Food Group (-16%).

To be fair, there were also a few successful picks in the top 100, like food maker Bellamy’s, whose 12-month total return was more than 600% thanks to Chinese panic buying of its organic baby formula.

But the real issue is that building portfolios around bottom-up analysis of the prospects for individual stocks or sectors is not a sustainable or systematic way of investing. You might get lucky. But then again, you might not.

In a concentrated portfolio, idiosyncratic influences can have an outsized effect. For instance, The Australianpicked software developer Infomedia as an IT play. But the non-renewal of a key buyer agreement forced a profit downgrade and its stock was down around 40% for the year.

However, even in a well-diversified Australian portfolio, it can be hard to avoid the drag from heavyweight stocks like BHP Billiton. Facing plunging commodity prices and an environmental disaster in Brazil, its stock hit 10-year lows recently. 

The Australian market is small by global standards and highly concentrated, the New Zealand market even more so. That’s why it makes sense to diversify as much as possible across different countries, sectors and stocks.

The idea is not to think of your portfolio in terms of individual stocks, but in terms of the broad drivers, or dimensions, of returns. These are your exposure to the market itself, to low relative price stocks, to small company stocks and to profitable stocks.

These dimensions of return have been shown to be sensible, backed by evidence, persistent and pervasive across different markets. Most of all, they are cost-effective to capture in diversified portfolios.

Of course, there is still no guarantee you won’t have a bad year in the market, but you can take comfort from knowing your portfolio is built around systematic differences in expected returns, not the whims of a newspaper.

Many happy returns!

An article published in the Australian Financial Review last week provided some revealing data about average fee levels in the superannuation environment – Wake up to Super Fees.

The article reported the following broad fee levels:

Average fees charged by MySuper schemes for not-for-profit industry schemes             - 1.01%

Average fees for comparable retail funds                                                                   - 1.32%

Total fees charged on actively managed retail default funds with $100k balance                           - 1.10% to 2.39%

Total fees charged on actively managed retail default funds with $250k balance                           - 1.05% to 2.33%

Total fees charged on passively managed retail default funds with $100k balance                         - 0.55% to 1.09%

Total fees charged on passively managed retail default funds with $250k balance                         - 0.52% to 1.04%

The article goes on to debate that the performance of a particular fund is not just about fees.  There can be no question that the end outcome for a member of a super fund is the net return after fees and taxes.  However whether an active or passive approach will achieve that outcome will be the topic of endless debate.

The research we have considered at A Clear Direction clearly suggests that keeping costs low should lead to a better outcome, on average.  Investment approaches that utilize a passive, index based approach to building portfolios generate lower costs for clients and in our opinion provide better long term outcomes.  This is why index funds are at the core of our investment philosophy for building client portfolios.

So how do the fees stack up for A Clear Direction’s approach?

The ARF article suggests that the typical default balanced fund mix is 30% defensive and 70% growth. Based on a 30 / 70 asset allocation mix (30% invested in cash & high quality fixed interest, 70% in growth assets such as shares and property) the indicative administration and investment fees that clients of this firm are charged are:

$100k portfolio                     0.79%

$250k portfolio                     0.78%

Please note that here are adviser fees on top of those amounts, as there would be if an adviser was involved with any of the average industry fee levels mentioned earlier.  We believe that our fee level compares very favourably to the fees across the superannuation industry and therefore puts clients ahead of the game in terms of long term net returns after fees and taxes.

Regards,

Scott

The latest S&P Indices Versus Active Funds (SPIVA) Scorecard has been released in the US.  Australian investor might ask what has that got to do with investors here in Australia?  We think it is very important for two reasons:

1. Most likely 50% of an Australian investor’s international share exposure is invested in US companies.
2. Academic research continues to show that the largest share market in the world provides a guide as to what will and does happen in markets around the world including the much smaller Australian share market

So what does the latest report tell us?

Yet again the US SPIVA Scorecard finds that active fund managers, those charging significant fees and spending significant resources to choose investments that will beat the average market, are failing to beat the benchmark S&P Index.

For the twelve months to the end of June, 2013:

• 59.58% of large cap funds,
• 68.88% of mid cap funds,
• 64.27% of small cap funds,
• 62.59% of global funds,
• 65.86% of international funds, and
• 74.53% of emerging markets funds all underperformed.

The only winning sectors for active managers were the US small cap growth sector and international small cap sector.

The five year data was even more condemning of active managers.

(Refer to the full SPIVA report for further details.)

What are the lessons for investors in Australia?

The key lesson for us Australian investors is that we need to be very careful in employing active fund managers as all we may be doing is helping the fund managers to buy their yachts, mansions and expensive cars and not actually providing any value to our portfolios.  Many studies show that a key reason for the underperformance is the extra fees that have to be paid to the fund managers.  This creates a headwind that is difficult for them to overcome.

There are many other reasons and we encourage you to take a look at our research pages to understand more about why active managers are not likely to be a great investment choice.

Please be in contact if you would like to discuss how to apply this research to your particular circumstances – scottk@acleardirection.com.au

Regards,

Scott