Australian equity fund managers with an income objective have delivered below-market returns in recent years, providing a cautionary tale to investors planning for retirement. Lonsec’s Australian Equities Sector Review, released today, shows that income sector funds covered by Lonsec returned 1.6% after fees in 2015, below the S&P/ASX 200 Accumulation Index return of 2.6%.
While the income strategy has tended to outperform over longer periods of time, there will be periods in which it fails to match market returns. According to Peter Green, General Manager of Equities at Lonsec Research, recent underperformance should serve to remind income investors to remain focused on fundamentals.
“We have been quite critical of what has started to become an unquestioning belief in the ability of income investing to deliver superior returns year on year,” said Mr Green. “What our research shows is that the income approach is not infallible. If investors take their eye off the fundamentals, returns can suffer as businesses are forced to unwind their dividend strategies. This can have a real impact on portfolios, especially those with larger weightings in the top 20 shares.”
Lonsec’s peer analysis shows that 13 out of 30 income funds covered by Lonsec failed to achieve a positive return in 2015, with returns ranging between 11.4% and -6.5%. On average, the income sector underperformed by -1.0% in 2015, and by -0.8% on a three-year basis. Although income has outperformed over five years, it has been by a modest 0.7%, although funds have continued to meet their income targets.
Growth funds deliver higher returns for lower risk
The 2015 year proved to be one of real dispersion between value and growth Australian equities funds. Lonsec’s growth sector provided a return of 9.3% on average (after fees) in 2015, compared to an average return of only 1.8% for Lonsec’s value peer group, which underperformed the S&P/ASX 200 Accumulation Index return of 2.6%.
According to Lonsec, Australian growth-styled equity fund managers are benefiting from high levels of earnings growth in emerging sectors, with many outperforming the benchmark despite lacklustre performance from the broader equities market.
“There was a real turning point in 2015 as growth funds overtook value funds in terms of performance,” said Mr Green. “While returns have varied across funds, growth managers generally have been able to take advantage of significant earnings expansion in key sectors, which has provided investors with some much-desired growth in their returns.”
Lonsec upgraded five growth funds in 2015, indicating that while returns have certainly been favourable, fund managers have also worked to improve processes and manage risk more effectively. This is especially important as volatility continues to be a major issue for investors, and fund discipline is likely to be tested further.
Heightened volatility has been associated with recent price index declines, including most notably at the top end, with ASX 20 shares losing -1.4% in 2015.
“Once again, we’ve seen more divergence in resources and energy versus current growth from industrials,” said Mr Green. “Recent large falls among some top 20 shares have tripped up many fund managers, and funds that have been overweight financials are now starting to struggle.”
However, Mr Green said that growth funds may continue to be favoured by investors looking for a way out of the global low-growth maze.
“Growth managers may continue to benefit from earnings expansion in key industrials, as well as shares that benefit from exposure to the US recovery or Chinese consumers,” he said.
Mr Green stressed that as the market continues to experience heightened volatility, fund managers will face a real test of discipline and process.
“Success in 2016 will depend on the ability of fund managers to stick cleanly to their objectives and ensure that the focus remains on long-term performance and sustainable returns,” he said. “Lonsec will continue to watch the Australian equities sector very carefully to help ensure that we have the best possible idea of how funds are performing.”
