Although this may be a rather confronting headline, Zenith believes it is the new reality that many Australian Shares – Large Companies fund managers are facing.
Over the past year, Zenith observed a number of fund managers restructure investment teams and change long standing investment strategies. Some fund managers have even decided to wind up their businesses. Zenith believes that managers are required to bring to market products that are differentiated from the norm to remain relevant in today’s competitive market.
Over the past 12 months, Zenith initiated coverage on 17 additional Australian Shares – Large Companies strategies. A key theme that Zenith observed was the differentiated nature of these strategies. Of the 17 additional products, none are considered a traditional “Core” offering. That is, none of these strategies are considered benchmark aware and/or relatively diversified, with the strongest growth experienced in the High Conviction category. Separately managed accounts (SMAs), on which Zenith initiated coverage last year, was the second largest growth segment. SMAs are typically concentrated in terms of holdings and can be easily tailored for individual investor needs. Zenith believes the strong growth in the High Conviction and SMA segments is reflective of managers adapting to the changing demands of an increasingly sophisticated investor base.
Zenith expects this trend to gain further momentum over the next few years as the use of a core/satellite approach within portfolios increases. The use of lower cost strategies has allowed investors to gain exposure to high conviction funds without increasing the overall fee budget of their portfolio.
The key attraction of a High Conviction fund is that it is typically the truest representation of a manager’s best investment ideas, constructed in a manner that has limited consideration for benchmark weights. As such, it was not surprising that the average High Conviction fund rated by Zenith outperformed both the S&P/ASX 300 Accumulation Index and its Core peers over the 10-year period to 31 March 2018. In addition, we found that High Conviction funds offered strong downside protection and greater levels of sector diversification.
Australian equities twist: High conviction funds deliver lower downside risk than core funds…
In its Report, Zenith compared the performance and downside protection of core and high conviction strategies in its rated universe of Australian equity funds over the ten years to March 2018. Over this period, the average high conviction fund outperformed the average core fund by 0.78% p.a. after fees. Investors typically pay a higher annual fee for investing in a high conviction fund, averaging 1.18% compared to 0.89% for core funds.
Contrary to what may be expected, when measured by ‘downside capture’, high conviction funds fared better than their core counterparts. Over the ten years to March 2018, when equity markets declined 1%, high conviction funds fell by 0.91% on average, compared to core funds which declined by an average of 0.94%.
…and more diversification than the S&P/ASX 300 Index
In a further counter-intuitive twist, high conviction strategies provided greater sector diversification than the benchmark S&P/ASX 300 Index – which has a much higher number of stocks.
Zenith compared sector diversification using a ‘diversity index’, which quantifies how equally weighted a fund strategy is between eleven different equity sectors. High conviction funds had an equivalent of 6.5 equal-weighted sectors, compared to the S&P/ASX 300 Index with a score of 5.5. The Index’s low diversity score is largely due to the high concentration in the financials and materials sectors.
Zenith notes that it is not surprising that high conviction funds, which are generally constructed with limited consideration for benchmark weights, offer greater levels of sector diversification. Investors need to be aware that holding a higher number of positions may not necessarily result in an increased level of diversification.
Value add of active managers in Zenith research universe
Over the 12 months to 30 April 2018, actively managed Australian Shares - Large Companies funds on Zenith’s Approved Product List (APL) achieved an average return of 8.1%, which equated to an impressive 2.4% outperformance of the S&P/ASX 300 Accumulation Index.
Looking to the next 12 months, Zenith notes that, in aggregate, managers have identified the S&P/ASX 51 to 100 segment of the market as being the most attractive.