There are occasions when the Australian equity market reminds investors of its cyclical nature, that it is dynamic, with the prospects of sectors or industries going up and down over time. Zenith believes the sharp rotation in market leadership over the past 12 months has highlighted this.
Despite generating an 18.1% return for the 12 months ended 31 March 2017, the average actively managed Australian Shares – Large Companies fund on Zenith’s Approved Product List (APL) endured its toughest relative return period in years.
Quan Nguyen, Senior Investment Analyst, said: “Our analysis identified several unexpected outcomes over this period, a time when the average rated fund in this sector underperformed the benchmark by approximately 2%.”
“Looking back over the seven-year period from March 2010 to March 2017, this result was an extreme outcome; active large cap funds, on average, generated positive excess returns on a rolling one year basis in virtually all observations over that time frame.”
Quality
Actively managed Australian equity funds under Zenith’s coverage tend to have a bias toward higher quality companies.
“Typically, these companies have consistent characteristics – high sustainable cashflow generation, high return on equity/invested capital, strong industry position/competitive advantage, low debt and strong management teams,” said Nguyen.
“Our analysis found that the quality premium follows a similar return profile to that of the excess returns generated by the average actively managed fund in Zenith’s coverage; that is, if the quality premium performs well, our rated actively managed funds tend to perform well. However, a quality bias has not been rewarded over the last year.”
Although quality may not have been rewarded over the past year, Zenith’s review notes that quality outperforms the benchmark over the longer-term. In fact, analysis shows that quality investing has outperformed the benchmark by 2.6% p.a. over the past 15 years, and quality has produced positive excess returns more often than not.
Resources
Following a similar thematic to that of the quality bias, the average fund maintained a significant underweight to resources over the period, potentially due to the apparent lack of quality within the sector. Zenith observed that the significant outperformance of resources relative to industrials has hurt active managers over the last year.
Small Companies
Given the apparent lack of coverage across the Australian small cap segment of the market, active managers tend to hold higher allocations to this segment, relative to the benchmark, with the view that they can generate additional excess returns.
“The underperformance of small caps has proved to be a headwind for active managers over the last year,” said Nguyen.
“The most notable market capitalisation biases among our rated funds were the average underweight to the S&P/ASX 20 (13%), and the average 7% overweight to stocks outside of the S&P/ASX 200 Index.”
Winners
Despite this, some funds were significant beneficiaries of the market conditions. In general, Zenith observed that the winners last year were some of the biggest losers the year before.
“There were only six funds out of 58 that outperformed the benchmark over the one-year periods before and after the market rotation,” said Nguyen.
The report notes that these funds do not come from one specific investment style – growth, neutral and value investment styles are all represented in this small sub-group.
“We are encouraged by this outcome as it reinforces our view that active managers should be able to outperform regardless of market conditions and investment style over a market cycle, albeit a very short one this time,” Nguyen concluded.
Separately Managed Accounts
In a relatively new development, Zenith has initiated coverage of Australian Shares – Large Companies SMAs in this year’s sector review. In this first review, Zenith identified five platforms that they believe to have sufficient capabilities in administering SMAs.
Summary of the Zenith 2017 Australian Shares – Large Companies Sector Review:
From an initial universe of 184 products:
- 13 were rated “Highly Recommended”
- 61 were rated “Recommended”
- 19 were rated “Approved”
- 2 were “Under Review”
- 2 were rated “Redeem”
- 87 were “Not Rated”
