Resources
"Necessary but not sufficient": Hurdles to overcome in equity manager selection
(Ausbiz - 29 November 2023)
Selecting investment managers is hard because track records are short and managers have growth or value strategies that are persistent, and whether growth beats value over short horizons is difficult to predict. But a starting point for manager selection is to consider three metrics: risk-adjusted performance, active share and fees.
Focusing on any one of these metrics in isolation will likely lead to future underperformance. Low-fee index funds are tax inefficient, performance is often mean-reverting because of persistent management styles and active share alone just measures the size of active bets. A high performing manager is likely to have modest fees, a track record of positive risk-adjusted returns and takes enough active bets to offset fees.
To pick a fund manager, look beyond three-year trailing returns
(Livewire - 24 October 2023)
Selecting an investment manager is hard because we have limited data to separate skill from luck. Ranking on three years of past performance is analogous to tipping the winner of the NRL or the AFL after three rounds of competition.
Researchers found that investment managers selected by U.S. pension plans, foundations and endowments underperform their opportunity set (the universe of funds that could have been selected) by an aggregate of 1 per cent over three years. This note summarises evidence on the characteristics of high-performing investment funds, providing some guidance on selection criteria. There are four key points worth considering.
Where do Analysts and the Market Disagree Right Now?
(Livewire - 20 September 2023)
Research tells us that analyst price targets have investment value, provided they are timely, based upon sophisticated valuation methods and unbiased. The latter two criteria could jointly be labelled as diligence. Investors will achieve higher returns by paying attention to analyst projections that are updated in a timely manner and for which analysts and the market disagree on price.
The 2023 fiscal year reporting season provides an opportunity to measure disagreement between the market and analysts for selected industries and stocks. If we isolate the analysts who estimated target prices and earnings just before the end of the financial year and promptly revise those projections after the reporting season, we can compare the market reaction to that of the analysts. We will have a signal where the market has over-reacted and under-reacted to earnings relative to analyst views. This means that those following analyst research in portfolio formation they will have the most value-relevant information.
History is not repeating itself
(addendum Ausbiz Interview - 23 August 2023)
This whitepaper delves into the implications for equity investors, specifically focusing on the recent trends and historical parallels. Notably, the diminishment of short-term earnings premiums, akin to the period just before the global financial crisis, has come to the fore. However, caution is warranted when interpreting these fluctuations in isolation as indicators of overvaluation or undervaluation.
Drawing a parallel to 2007, the reduction in earnings premium then was rooted in a substantial appreciation in share prices, outpacing earnings growth, unlike the present situation. In contrast, the current narrowing of the earnings premium in 2023 is attributed to an inflationary shock that promptly influenced bond yields in anticipation of forthcoming central bank policy adjustments.
Examining the past two years, an inflation-driven surge in bond yields, preceding central bank actions, has been discernible. These endeavors to temper inflation have been reflected in controlled price dynamics, restrained discretionary spending, and a consequential revision in analysts' earnings forecasts over the ensuing 24 months.
While historical inflationary aspects resonate, a critical departure emerges in the trajectories of analyst earnings projections between the two periods. In essence, while history's inflationary echoes persist, this whitepaper dissects these complexities, providing a comprehensive understanding of the implications for equity investors.
High Yield Portfolios
(addendum Ausbiz Interview - 28 June 2023)
High-yield stocks have historically outperformed low-yield stocks in the United States, Hong Kong and globally, but returns are sensitive to interest rate fluctuations. Standard and Poor’s (S&P) estimates that $3.6 billion is invested in Australian-listed exchange-traded funds (ETFs) with a high yield strategy, a figure which has grown at an annual rate of 21 per cent over ten years.
Portfolios of Australian-listed companies trading on high yields have produced a 2.3% annual advantage on inflation-adjusted returns versus the wider market over a 40-year span, with half originating from imputation benefits. Although high-yield investments display below-average market risk exposure, they bear above-average interest rate risk. A 1 per cent increase in the 10-year government bond yield is associated with a minus 0.6 per cent return to high-yield portfolios. That risk exposure doesn't necessarily represent a trading opportunity for most investors - if you can forecast bond yields, then trade bonds - it merely demonstrates that maintaining a long-term outlook is crucial and that portfolios are exposed to multiple risks. A high imputation yield portfolio that is diversified across industry sectors can have volatility approximating the broader market. The comparatively low volatility of mature, profitable companies offsets the incremental risk of holding a subset of the broader market.
During a June 2023 interview with Andrew Geoghegan from Ausbiz, Jason Hall presented this topic, and the attached white paper outlines the performance of high-yield investing in Australian listed stocks over 41 years from July 1982 to May 2023.
Descision-Making by Investors
(addendum Ausbiz Interview - 31 May 2023)
As we head into the last month of the financial year, superannuation investors are likely to turn their minds to asset allocation. It is interesting to consider how investors make decisions in light of recent returns and whether this decision-making process is optimal for their portfolio.
Research on investment decisions of Australian superannuation investors shows that wholesale investors who also do not switch their asset allocation mix earn an average of 1-2 per cent higher annual returns than retail investors who also switch their asset allocation mix. We also have evidence from the U.S. that clients of retail brokers are pre-disposed to buy attention-grabbing stocks. In aggregate, we can conclude that retail investors are likely to make investment decisions on the basis of recent, attention-grabbing news, which could be why their asset allocation switches are poorly timed.
During a May 2023 interview on Ausbiz Jason Hall presented this topic and the attached white paper outlines the issues to consider for Superannuation investors in setting asset allocation.
Franking credits explained
In Australia, franking credits effectively eliminate double taxation for Australian resident investors in local companies by allowing companies to pass on a tax credit equal to the amount of tax the company has already paid on the dividend.
A franking credit is a tax credit paid by companies to their shareholders at the same time as dividends are paid. Since corporations have already paid taxes on the dividends they distribute to their shareholders, the franking credit allows them to allocate a tax credit to their shareholders. Depending on their tax situation, shareholders might then get a reduction in their income taxes or a tax refund.
The Australian Tax Office (ATO) website contains numerous articles of explanation for different Australian resident investor types.
Evidence-based, systematic investing explained
There’s an ongoing debate in the investment community over which approach to building a stock portfolio is best. Is it active or passive investing? Few investors realise there is a third option, which we believe is superior to either of the first two: evidence-based, systematic investing.
Evidence-based, systematic investing provides a perfect balance for investors. It allows investors to outperform the market while adhering to passive investing principles. It is an approach that emphasises data and quantitative techniques to build portfolios — relying less on the discretionary decisions of individual portfolio managers.
At Hamilton12, we apply apply rigorous research and measurement techniques to all aspects of the investment process. Our portfolio construction approach is grounded on rigorous theory, supported by empirical evidence, market segmentation and the impact of taxation on investment returns.
Active v. Passive. SPIVA explained
SPIVA stands for 'S&P Indices Versus Active', and it is the name for a regular series of research reports that compare the performance of actively managed funds to appropriate benchmarks. The primary role of the SPIVA Scorecards is to help inform a sometimes unfortunately noisy debate over the relative merits of active and passive investing.
The scorecards do this by providing data on where (and when) actively managed funds have been performing well (or poorly), over both short and long-term horizons, in various markets arounds the world - as well as offering a range of deeper statistics and analysis on active fund performance.
The SPIVA reports stand in a long-running tradition of academic and practitioner commentary on the relative merits of active and passive investments. SPIVA data point to a number of conclusions;
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Most active managers underperform most of the time.
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This conclusion originally came from examining managed fund performance net of fees.
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Gross of fees, most active managers underperform most of the time.
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Most institutional managers underperform most of the time.
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After adjusting for risk, most active managers underperform most of the time.
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The tendency for underperformance typically rises as the observation period lengthens.
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These conclusions are robust across geographies.
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When good performance does occur, it tends not to persist. Above-average past performance does not predict above-average future performance.
Click on the S&P Dow Jones Indices logo to find out more.
Take a deep dive into the active v. passive debate as S&P DJI's Craig Lazzaro explores what two decades of SPIVA has to say about why active has historically tended to underperform passive around the world.