Active returns more luck than judgement

Fewer than half of active fund managers that have beaten the benchmark in their investment category have achieved positive excess returns as a result of management skill over the last five years, according to research from Morningstar.

The findings have lead Morningstar head of consulting Anthony Serhan to reiterate warnings he issued after releasing a similar report in August 2003 about the risks associated with ‘chasing returns’.

The independently-conducted study, which was commissioned by index fund manager Vanguard Investments Australia, examined 369 funds to determine how many had beaten the index over five and seven year periods after fees, and how many demonstrated skill in doing so.

“The skill test has two components to it, the first is the level of excess returns and the second part of it is the volatility of these returns,” Serhan said.

He said the study’s methodology separated those managers that had beaten the benchmark due to a few large monthly excess returns from those that had sustained strong performance.

Serhan said that while 55 per cent of wholesale listed property funds had beat their index, the level of excess returns had been so small that it was not possible to say with confidence that this was due to management skill.

Similarly, the research showed that while 41 per cent of retail Australian equities funds produced returns above the S&P/ASX300 Accumulated Index over seven years, only 4 per cent passed the skills test.

“Drawing conclusions from simple returns figures is dangerous. A return figure tells you where the fund finished - it doesn’t tell you how the race was run,” Sherhan said.

Fees were also revealed to have a major impact on positive returns to investors, with Serhan commenting that funds that charged higher fees would find it more difficult to add value against the benchmark than cheaper funds.