• For the 5 years to the end of June, more than 60% of all active funds underperformed relative to their benchmarks.
• The S&P ASX200 has outperformed approximately 65% of active Australian equity funds over the 5 years. (72% over the past 12 months)
• 70% of Australian equity small-cap funds out-performed the S&P ASX200 Small Ordinaries (Our preferred Dimensional Small Company Trust beat this index by 4.40% over the 5 year period.)
• Over a 5 year period the MSCI World ex Australia index has outperformed more than 77% of actively managed funds. (57% over the past year.)
• The S&P ASX 200 A-REIT index has outperformed more than 62% of active A-REIT funds over the past 5 years. (Outperforming 88% of active funds over the past year.)

Regards,

Scott

Users of our website, through our User Voice feedback forum, have requested that we regularly update the graphs outlining the performance of the Dimensional trusts that we use in building portfolios for clients.  In response to this feedback we have updated these graphs to reflect performance up to the end of July 2010.

Commentary:

The graphs show a strong month of returns for all asset classes however returns have been impacted by the difficult conditions experienced in April, May & June of this year.

Over the long run, the graphs continue to clearly show the existence of the risk premiums (small, value and emerging markets) that the research tells us should exist:

Australian Share Trusts - 7 Year returns

International Share Trusts - 7 Year returns

NB - These numbers are average annual returns for the 7 year period which are slightly higher than the annualised returns.

Please click on the following link to be taken to the graphs - Dimensional Fund Performance Graphs.

For anyone new to our website, it is important to point out that we build investment portfolios for clients based on the best available academic research.  Take a look at our Building Portfolios and Our Research Based Approach pages for more details.  In our view, this research compels us to use the three factor model developed by Fama and French.  In Australia, the most effective method of investing using this model is through trusts implemented by Dimensional Fund Advisors (www.dimensional.com.au).  We do not receive any form of commission or payment from Dimensional for using their trusts.  We use them because they provide the returns clients are entitled to from share markets.

However, academic theory is nothing if it can not be implemented and provide the returns that are promised by the research.  Therefore, we like to provide the historical returns of the funds that we use to build investment portfolios.

Please let us know if you have any feedback regarding these graphs by using the Request for More Information form to the right or via our User Voice feedback forum.

Regards,

Scott Keefer

It is understandable that many investors may be feeling a little uneasy at present.  Markets continue to be volatile, up strongly one month and down the next.  The big issues we tend to be focusing on are European debt, austerity measures in Europe to reign in the debt, the sluggish US employment numbers and worries about a double dip, and Chinese government efforts to slow down growth to help manage possible asset price bubbles.  Just writing this causes me to want to take a tablet and have a lie down.

One set of data that does not seem to be getting the same airtime from the financial media are earnings being generated by local and international companies.  The recent US reporting season has been strong and in part helped global markets along through July and early August.  In the end it is the earnings generated by companies that provide a return to long term investors and should be a key consideration when investing.

A report in today’s Australian Financial Review written by David Bassanese – “US growth will avert earnings slump” – provides some interesting data about the earnings reported in the US.  Bassanese outlines that price to forward 12 month earnings (i.e. forecast earnings) for the US S&P 500 is sitting around 12.3, 23% below its 10 year average of 16.  Longer timeframes suggest the average ratio is more like 15 times forward earnings.  Either way this simple statistic suggests that US share prices are good value at present levels.  This might well be because share prices are factoring in the chances of future economic head winds and is not in itself a signal to buy, buy, buy, but it does suggest that if you have a long term window, buying assets now could provide you with access to a well priced earnings stream into the future – what should be the key focus of a long term investor.

Unfortunately price to earnings ratio do not provide an accurate buying guide.  The ratio could fall further and company earnings could falter for instance if the US economy falls into another recession.  However it provides a glimmer of hope in what seems to be a doom and gloom story in the media.

So is now the time to buy or sell?

As always, our firm’s approach is not to try to time markets but rather structure portfolios for the future, keeping enough aside in cash and fixed interest to at least cover the next 7 years of income requirements and then spread the remaining assets across a diversified portfolio of Australian and international shares including listed property.  Those who, after taking their individual needs into consideration, have the capacity to invest regularly over time, now is still a good time to be making these investments.

For more information about our approach please refer to our Building Portfolios page.

Regards,

Scott Keefer

Investors frequently seek external validation to ease the anxiety of putting their money at risk. Problem is there is no guarantee that a "five-star" rating on a chosen fund will lead to a "five-star" investment experience.

It is human nature for consumers to seek comfort in the idea that the products they are buying are proven in the marketplace. That need is met by ratings agencies that play a legitimate and vital role in providing independent assessments of various investment products.

Those assessments are made in professionally compiled and detailed reports that can be a useful yardstick for investors and their advisors in comparing funds so that they can make a fully informed decision.

But despite diligent cautions from the agencies about chasing returns, problems arise when consumers blindly extrapolate star rating systems for various funds into imagined future performance.

The risks of this approach were highlighted in a survey by US private wealth management business Burns Advisory Group, which went back to 1999 to study the subsequent 10-year performance of Morningstar's five-star funds.¹

Burns found that of the 248 funds rated five-star by Morningstar on December 31, 2009, only four were still receiving that rating a decade later. Of the original sample, 87 had ceased to exist. Of those still existing, all had been downgraded to an average of just under three stars. Even worse, in all categories except international stocks, the average performance for five-star funds over this 10-year period was worse than the average for all funds.

"These findings imply the star ranking methodology leaves long-term investors in the lurch," Burns concluded. "If nothing else, it demonstrates clearly why investors should not rely on one measure as their sole research tool."

But it is not just unsophisticated investors that are chasing performance. Another recent report suggests that even wealthy individuals and institutional investors can be blind-sided by past returns.

The study by researchers at the European School of Management and Technology, quoted in The Economist magazine, looked at how investors allocated money to hedge funds over 10 years from 1994.²

The researchers found that the funds that had performed well in the previous three quarters attracted significantly more money than their competitors. In other words, the supposedly "smart money" was chasing past returns.

Bear in mind, also, that indiscriminately chasing returns can be even more costly with hedge funds, which typically charge management fees of 2% or more, plus 20% of the returns they generate for clients.

Given the large body of academic evidence that it is extremely difficult to predict market returns with any confidence, it should be evident that past returns should not be the foundation for choosing one fund over another.

Leading academics Gene Fama and Ken French, in a recent study of mutual fund performance, showed how hard it is for investors to distinguish skill from pure chance in analysing the returns of individual funds.³

So what should an investor and his or her advisor weigh up in making a decision? The key here is to focus on items within their control, such as:

While many of these attributes can lead to good outcomes for investors, they are no guarantee of positive returns every year. Anyone who makes those sorts of promises risks disillusioning those who put their faith in them.

But the above characteristics can give investors comfort that their money is being invested in a consistent, transparent way and that ensures that when the targeted premiums kick in, they are positioned to receive them.

This is a grounded, completely defensible approach. The alternative is that by reaching for the stars, investors are left clutching at straws.

1. McGuigan, Tom and Courtenay, Tim, Star Gazing: Five Star Funds Revisited, Burns Advisory Group, April 2010

2. Buttonwood, Who's the Patsy?, The Economist, May 29, 2010

3. Fama, Eugene F., and Kenneth R. French. 2009. Luck Versus Skill in the Cross Section of Mutual Fund Returns, SSRN