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Sunday, March 1, 2009
Comparing the options

As we all know, it was really difficult to hide from capital loss in equities last year, both locally and internationally. There is no point in regurgitating numbers; they are all red and a deep blood red at that.

Fortunately, if we are investing in equities, short term equity performance - anything less than at least three years - is really of little importance as the average equity investor should only be there for the long term (5+ years). A common question that surfaces is whether investing with active managers results in a higher return (net of fees) than investing with passive or tracker style funds.
“As we all know, appropriate diversification (asset class, geographic, stock etc.) has been shown to increase return and decrease risk and, for the long-term the South African investor who has equity exposure, we strongly feel that having some investments overseas is generally to one's benefit,” says Greg Flash of Alphen Asset Management.
Let us look at how active offshore managers have been fairing, both nominally and versus their respective benchmarks and markets. All returns are from the perspective of the South African investor (in rand terms).
Looking at the three main regions we follow, Europe and North America, as well as the general global view, data from Morningstar shows that for the calendar year of 2008, everyone lost money - both the active managers and the indices (and hence the passive/tracker funds too). “But, as we said, this is really of little consequence.”
Looking at longer periods: 3, 5, 10 and 20 years ending 31st December 2008, we see that the MSCI indices for all three markets had nominally positive returns for all periods three years and greater.
The table shows the average returns for the top two quartiles of active equity managers, the average return of all the active equity managers and the index returns (as a proxy for the passive investments).
Table: Annualised Returns of Active Managers vs. their Benchmarks (in rands)

Comments Flash, “From this table we can see that, for the majority of the time periods, the average active manager's return exceeded that of his respective indices for his respective regions. Further, in all periods of three years or longer he has demonstrated positive nominal returns.
“Rather than simply accepting the average manager's returns in each of these regions, let us assume that through our investment process we are able to invest with managers that are better than average. Let us assume that one had invested with managers whose returns had, over the various periods, consistently appeared in the upper half of each region's ranking, i.e. the average manager in quartiles 1 and 2.
“If this had been the case, we can see that the excess return (greater than the respective sector averages) would have been significantly higher. We do have to be mindful of the survivorship bias on this data - the averages are only for the funds that still exist - which most likely has increased the returns for the average manager.”
Looking at the Global sector, one can note that the power of compounding the 2.5% and 0.7% excess annualised returns for the 10- and 20-year periods would have resulted in a significant outperformance of the returns one would have expected from a passive investment mirroring the MSCI World benchmark.
“Yes,” says Flash, “we acknowledge (as ever) that past performance is not an indication of future performance, and that one can never be certain today that, over a 3- 5- 10- or 20-year period one's holdings will consistently be able to average in the top two quartiles. However, this data does seem to indicate that the average (and better than average) offshore active manager has been able to produce returns better than the market (and hence is a better investment choice than a passive index-mirroring) investment over the long term.”

Copyright © Insurance Times and Investments® Vol:22.3 1st March, 2009
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