Investing: Marathon or Sprint?

2015 was full of hope and optimism for a triumphant performance for the share market in the new year. Alas, it was nothing but disaster.

Fear disaster not. The benefits of active management is usually most evident in more challenging markets, according to Mercer. We’re told the last 12 months have provided plenty of evidence that this remains the case. That’s a relief.

Here are the top five performing Australian share funds for the 2016FY:

FundsMercer

Source: Mercer

These are some serious one year returns. Any investor would be pretty happy with these. So why wouldn’t investors direct their investments into these funds? Chase the guys and gals that are returning the big numbers. Simple right?

There are always funds that shoot the lights out. This is fact. What we don’t know however, if it’s because they’re actually super skilled or just plain lucky. I don’t think anyone can say they’re aren’t any skillful investment managers out there. There certainly are.

The difficulty is identifying these managers in advance in order to participate in these returns. Why does this matter? Simply because these returns are not only inconsistent, they don’t last forever.

To show you what I mean, and to put things into perspective, I plotted the performance of these funds over a slightly longer time frame (5 years). I mean, who looks at things over a 12 month period? (this question is rhetorical)

Mercer5YRSource: Thompson Reuters Eikon

Most funds had been broadly tracking each other up until about 2015, when the Macquarie Alpha Opportunities Fund’s performance skyrocketed. Clearly a stellar performance. Even over the last five years, most of these funds have performed very well in absolute terms.

It’s important to also look at relative performance. What if you simply invested in a high yield index over this same time frame? To put the performance of the top performing funds into perspective, I’ve plotted the performance of one of the most widely used Exchange Traded Funds (ETF)  – Vanguard’s Australian Shares High Yield Index ETF, which costs a mere 0.25% pa (compared to 0.95% pa plus a 15% performance fee for the Bennelong High Conviction Fund). What this means is that in order to ‘outperform’, investors in funds that charge a lot more, must first pay their way before participating in any market return.

Okay, so here’s the chart with Vanguard’s ETF in orange:

Mercer5YRVHYSource: Thompson Reuters Eikon

Now this makes things interesting. Over the last five years, which is a common start date for all but one fund (Martin Currie), all but one of the top performing funds have under performed a simple benchmark. Yet the costs to invest in these funds are almost four times the cost of a simple benchmark, plus a performance fee.

In absolute terms, the returns of these funds are a fantastic result. In relative terms, they’re nothing to get too excited about.

Don’t get me wrong, there are and will continue to be funds that perform better than others, and better than an index during different periods of time. And for this reason, I don’t believe index funds will completely overtake active funds. This is because chasing the next wildly performing fund is tempting and enticing.

It’s just unfortunate that the odds of financial success are stacked up against you. I’m not here to introduce theories to you. I’m here explaining fact.

The first table below, provided by SPIVA (S&P Index Versus Active), shows us the performance of the average fund and compares this to the relevant benchmark:

Peers

For property, bonds, and international shares, actively managed funds just don’t cut it. Each failing to outperform their respective indexes over the last 5 years. The average Australian share fund however, is the one asset class that has been able to outperform over the last 5 year (to December 2015). Having said this, only by 0.18% pa.

Remember this is only an average. Investors are highly unlikely to be investing in all available funds. Investors are more likely to invest in a basket of actively managed funds in an attempt to ‘beat the market’.

According the the latest SPIVA data below, most funds, 2 out of every 3 funds failed to beat the ASX 200. This is the challenge for investors. That is, giving it their best shot in finding the 1 in every 3 actively managed fund that outperforms the ASX 200…in advance.

The chart below shows us the percentage of funds who have underperformed the comparison index:

SPIVA

Source: S&P Dow Jones Indices LLC, Morningstar. Data as of Dec. 31, 2015. Table is provided for illustrative purposes. Past performance is no guarantee of future results.

The basic premise that is that there will always be big winners. There will also be big losers. Investing is a zero sum game. For every winner there is a loser. The research indicates that it’s difficult to be on the winning side of each transaction consistently and for long periods of time. Therefore, before you start gambling away your hard earned wealth. Take a look at the facts.

We all know investing is a marathon that requires patience and discipline. The chart below is what real long-term investing is about. It’s the performance of the ASX top 50 stocks since 1986.

MAXSource: Thompson Reuters Eikon

Unfortunately it’s difficult to think about investing over 30 years. Simple. Boring. 440.95% return. Sadly, for most other actively managed funds, they just don’t last the journey.

Investing is a marathon, not a sprint.

Life’s About More Than Money

Life's about more than money

I spend a bit of time on Twitter. It gives me good coverage of what’s going on in the world – super quick. Last night I came across this tweet from NAB:

I’m yet to work the technicalities of embedding tweets into this note, so you can watch the campaign by clicking on the video below:

Life’s about more than money. Said no bank ever. Bizarre, right? Notwithstanding, the ad is brilliant. So powerful. As a father of a two year old boy (pictured above), and with another little bundle of joy on the way, the ad resonates really strongly with me (it even raises a few hairs on the back of the neck). Well done NAB, hats off to you.

The voice over states that, on average, after 18 years, you spend $450,000 on your child with little or no financial return on your investment. So, why do people have children? Clearly, it’s not about the money. There’s more to it than that.

When I’m not on Twitter, I’m helping a few clients with their finances and investments. The most difficult part of my job, yet the most satisfying, is spending time uncovering their goals and aspirations. What’s their life is really about? What are their goals and why? What makes them happy?

If you think loads of money, fetching good looks, or the admiration of others will improve your life – think again. A study by the University of Rochester set out to determine which types of goals led to a happier life.

They interviewed a number of university students and asked them about their goals in life. They separated their responses into two groups; extrinsic or ‘profit’ aspirations and intrinsic or ‘purpose’ aspirations. Extrinsic aspirations were centered around becoming wealthy or achieving a certain look. Intrinsic aspirations were centered around growing as an individual, helping others improve their lives, and contributing to their community.

Over time, they tracked their progress. They found that those with purpose aspirations reported much higher levels of satisfaction and self-esteem about their lives. In fact, they also reported lower levels of anxiety and depression. On the other hand, those with profit aspirations weren’t any happier than when they were at university. These students also exhibited higher levels of anxiety and depression.

In his book Drive: The Surprising Truth About What Motivates Us, Daniel Pink interviewed the authors of this study, and here’s what they had to say:

“The typical notion is this: You value something. You attain it. Then you’re better off as a function of it. But what we find is that there are certain things that if you value and if you attain them, you’re worse off as a result of it, not better off.”

Failing to understand this conundrum — that satisfaction depends not merely on having goals, but on having the right goals — can lead sensible people down self-destructive paths. If people chase profit goals, reach those goals, and still don’t feel any better about their lives, one response is to increase the size and scope of the goals — to seek more money or greater outside validation. And that can “drive them down a road of further unhappiness thinking it’s the road to happiness.”

Different people want different things. For some, it’s about giving their children an education they never had, or giving back to a community who may not be as fortunate. For others, it’s about building a home where they can spend quality, uninterrupted time with their loved ones. Ask yourself why? Why do we direct funds and or our time towards investments that don’t generate a financial return?

Our long experience in wealth management has consistently shown that our clients don’t view the accumulation of money as the end game. They see it as a means to an end, a way of achieving their desired lifestyle.

Your core values about money essentially affect many of the decisions you make in life. So, conversely, when you understand and are clear on what you want to do with your life, the right financial choices and decisions for you personally will become much clearer.

Life is about more than money.

The Wine Lovers’ Guide to Investing

Wine lovers guide to investment

Savouring a vintage wine is one of life’s great pleasures. But often overlooked in the joy of consumption is the carefully calibrated journey from grape to glass. Similar levels of care are critical to good investment outcomes.

Variables

A host of variables can determine whether a wine is great, good, mediocre or undrinkable. These include the quality of the grapes, the soil, the position of the vineyard, the weather, the irrigation and the timing of the harvest.

And picking the grapes isn’t the end of it. The harvest must be sorted, the grapes crushed and pressed, then fermented, clarified, aged and bottled. At any stage of the process, a lack of attention to detail can spoil the final outcome.

Attention to detail

As in winemaking, investment management requires attention to detail—researching and identifying the dimensions of expected returns, designing strategies to capture the desired premiums, building diversified portfolios and implementing efficiently.

Just as winemakers don’t have any say over the weather, investment managers can’t control the markets. Not every harvest will produce an excellent vintage, but expert professionals can still maximise their chances of success by putting their greatest efforts into things they can influence.

For winemakers that may be taking extreme care in picking the grapes at a time that delivers the desired balance of acidity and sweetness. For investment managers, it can mean precisely targeting the desired premiums while ensuring sufficient diversification to lessen idiosyncratic risk in the portfolio.

Art or science

Winemaking is as much an art as a science While fermentation comes naturally, the winemaker must still guide the process, using a variety of techniques to ensure the wine is as close as possible in style and flavour to what he is seeking to achieve.

Similarly in investment, real world frictions mean that basing one’s approach purely on a theoretical model is unlikely to be successful. For instance, trade-offs must continually be made between the expected benefits of buying particular securities and the expected costs of the transactions. Managing the effects of momentum and being mindful of tax considerations are among the other issues to be balanced.

External events

Just as in viticulture, investment outcomes can also be affected by any number of external events—such as the imposition of capital controls in an emerging market, or changes in regulation, a severe financial crisis, or a major geopolitical event.

Dealing with uncertainty and navigating the “unknown unknowns” are part of the job. So investment managers must build into their processes a level of resilience, through diversification for instance, so they have sufficient flexibility to work around unforeseen events.

Bringing it together

Ultimately, the benefits of discipline and attention to detail are easy to overlook. Great ideas count for a lot, of course. But great ideas, without efficient implementation can mean even the best grapes in the world go to waste.

This article was originally written by Jim Parker, Vice President of DFA