Frontier principal consultant David Carruthers

New research from Frontier Advisors says the Productivity Commission’s ‘best in show’ list could have bad outcomes for Australian retirees and workers.

The paper points to “an insatiable desire for consolidation” that comes from regulators, politicians and industry bodies and suggests they shift from choosing the best performing funds to removing underperforming funds.

Frontier’s research delves into a range of variables to find correlations between size, net returns, cash flows, allocation to growth assets, and fees and costs in order to identify where the focus for forcing consolidation should lie.

The analysis reveals that while there is a clear relationship between fund size and net three-year return, this factor is by no means conclusive.

As it turns out, two funds less than 1 per cent the size of $150 billion AustralianSuper, were the highest-performing funds over that period.

Examining the most expensive operating funds also showed that while greater size generally reduces cost per member, it is not always the case with five funds boasting around $5 billion in assets having a cost ratio below the majority of funds.

“While logic would suggest the lowest operating costs should result in the lowest fees being charged to members, this relationship doesn’t always hold true either,” Frontier states.

Of most interest, however, is the analysis on the movement of funds in and out of the best performing categories over time.

The study reveals that of the top ten performing funds for the three years to 30 June 2018, four had dropped out of the top ten via the same comparison just six months later.

“Choose a different end date, period or peer group and the results will be different, often markedly,” the paper stated.

Underperforming funds, however, are more likely to repeat their performance.

Eight of the ten worst-performing funds held their bottom ten position over the same six-month window, according to the study.

Frontier principal consultant David Carruthers says that risk-adjusted performance is important to consider in any assessment of which funds perform better than others.

“There are a range of ways to measure risk. Has a fund allocated more to growth assets, has a fund produced a lower overall volatility from one period to the next, what is the expected frequency of negative returns?,” he argues.

“All of these variables have a clear correlation to higher long-term performance.

“To determine the value a particular fund offers requires an assessment across a wide range of factors that includes the level of fees and costs, size of assets, performance across a range of time periods, risk profile and qualitative factors such as member services.

“The focus should be on improved outcomes for members, not just less funds for the sake of  it.”

Carruthers said perhaps the new member outcomes legislation will set a minimum standard of delivery, across a range of areas that funds need to provide.

“That would give both funds and members certainty and confidence around what constitutes success.”

According to the asset consultant, the ‘best in show’ conversation stopped short of defining persistent underperformers.

Carruthers doesn’t think it’s smart to look at funds based on some “very simple” calculations and that was the idea behind producing the research.

“We know from ASIC that past performance is not necessarily a guide to the future,” he adds.

2 comments on “Frontier underlines problems with best in show list”
  1. Danielle Stitt

    Completely agree that the implementation of the “best in show” recommendation is complex and the industry needs to flush out all the ramifications sooner rather than later. In my view, time horizons over which funds are “judged” are critical and should be matched to the goal of the investment. So for a superannuation saving, a 3 year time horizon is probably a factor of 10 too short. Shouldn’t a fund’s 10 year track record be the minimum?

  2. Christoph Schnelle

    This research from Frontier sounds very sensible. There are additional ways to game the system. One example is launching five different funds – all with the same risk metrics but different assets, for example choosing between different countries or assets with the same risk assessment (property/shares) or large/small or growth/value etc and you will get markedly different outcomes with your top performing fund having a good chance of making it into the Productivity Commission’s top ten.

    Fundamentally the problem is, as Frontier found, top performance does not repeat any more than randomly (with a very few, famous exceptions you can identify after the fact), only bottom performance does. That has been found to be true across all funds over decades (Fama/French).

    Strange that the Productivity Commission would be this naïve.

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