It’s the age old investment question: do you set and forget, or tinker to add value?
In an attempt to find an answer, and separate the investment ‘Hares’ from the ‘Tortoises’, Money Management commissioned PortfolioConstruction Forum to produce a new research report.
The Hare and Tortoise analysis compares a ‘market timing’ strategy — the Hare — with a ‘buy-and-hold’ strategy — the Tortoise, over a variety of asset classes and investment horizons.
The outcome reinforces the tried and tested adage — it’s ‘time in the market, not timing the market’ that is important.
The results also show that using simple compound returns — as most advisers do to measure product performance — paints a very different, and perhaps deceptive, picture when compared with returns based on a rolling average.
How the Hare and the Tortoise ran their race
The Tortoise invested $10,000 at the beginning of each five, seven, or 10-year survey period, in each of four survey asset class categories — Australian equities, international equities, Australian fixed interest and international fixed interest — and held that investment through to June 30, 2004.
The Hare also invested $10,000 in each category at the beginning of each period, but then invested and divested funds in proportion to the industry net flows to that asset class for each calendar quarter of the period, using Plan for Life market share data.
If the industry net flow to an asset class was 10 per cent of the average funds under management (FUM) over the quarter, the Hare invested an additional 10 per cent of its then lump sum in that asset class over the quarter.
And conversely, if the industry net flow was -10 per cent of average industry FUM over a quarter, then that quarter the Hare cashed up 10 per cent of its then current lump sum invested.
Because investment patterns vary greatly between the platform, wholesale and pure retail sectors, a Tortoise and Hare were created for each of the three sectors.
Each Tortoise and Hare invested in the ‘average’ public offer fund in each sector.
The ‘average’ fund’s returns were assumed to be the simple-weighted average of the returns achieved by all funds in that asset class, using Plan for Life investment return data for the asset classes.
And to further level the race track, two types of returns were analysed for each Hare and Tortoise scenario:
n the simple compound (or ‘point to point’) 10, seven and five-year returns to June 30, 2004; and
n the rolling average one-year return over the 10, seven and five-year periods to June 30, 2004.
Who came out in front?
When using simple compound or point-to-point returns, the Hare came out on top, across most asset classes and time periods. This was especially true for domestic asset classes.
Deirdre Keown, analyst with Brillient!, the publishers of PortfolioConstruction Forum, says, “This is understandable as it is far easier to be an expert Hare in a small, local market — and hence make good investment timing decisions — than it is to be an expert investor in offshore markets”.
However, once rolling average returns were calculated, the race was much too close to call, with the Hare and Tortoise finishing in almost a dead heat across 10, seven and five-year investment periods in most asset classes.
Furthermore, Keown says, given that entering and exiting funds usually attracts fees from the fund manager, platform and/or intermediary used, the actual returns achieved by the Hare would have been lower than those of the Tortoise.
Given that the Hare’s strategy mirrored the net cash flow strategy of the industry, it’s fair to conclude the combined investment timing efforts of platform investors, pure retail investors and pure wholesale investors has been “a waste of time, by and large”, Keown says.
“While it may appear that the Hare’s market timing strategy paid dividends, in fact on average, the Tortoise buy-and-hold approach would have given a better end result after fees.”
Australian equities
If ever there was an asset category in which the Hare was going to outperform the Tortoise, Keown says, then Australian equities would have to be it, at least in the platform and wholesale sectors.
The Australian equity market is relatively small, and information is accessible and dispersed, she says, so being an “expert Hare” in this sector is relatively easier compared to many other sectors.
In addition, the Hare is a more active investor in the Australian equities asset class than in the other categories, and bets are larger. The average net cash flow changes in Australian equities was 0.69 per cent of FUM per quarter.
True to form, all three Australian equity Hares outperformed their Tortoise competitor, and significantly so, on a simple compound return basis.
All three Hares also outperformed their Tortoise competitors on a rolling average basis over the three periods, by around 0.8 per cent to 1.2 per cent per year.
If the fees associated with the Hare strategy were less than those numbers per year — which Keown suggests is a “big if” — then the compounding effect of outperformance would be considerable.
International equities
International equities, by contrast, is the sector you’d expect the Tortoise to come fully into its own, because of the difficulty of timing investment decisions in offshore markets.
The Tortoise achieved significantly better returns than the Hare over all categories and investment periods on a simple compound return basis.
On a rolling average return basis, however, the Hare turned the tables on the tortoise in all categories and investment periods.
The outperformance in the platform and pure retail sectors was in excess of 1 per cent per annum, with, again, a considerable compounding effect over time.
Of course, the true benefits to the Hare will depend on the fees associated with any particular investment strategy.
Outperformance in the wholesale market is considerably lower, at 0.67 per cent per annum, which Keown suggests may be because few and smaller investment/ divestment moves were being made.
The wholesale Hare posted net cash flows of about 1.5 per cent of FUM per quarter on average, which is active, but far less active than those of the platform Hare, which posted average net cash flows of 2.5 per cent of FUM per quarter.
Australian fixed interest
On a rolling average return basis over the three survey periods in the Australian fixed interest category, the Hare and Tortoise achieved almost identical results, making the Tortoise the after-fees winner.
On a simple compound return basis, by contrast, the platform Hare and wholesale Hare outperformed the Tortoise over all three periods in the Australian fixed interest category.
However, the pure retail Tortoise outperformed the Hare on a simple compound basis, which Keown says isn’t surprising, given that retail investors are the least likely to receive investment advice, putting them at a decided disadvantage when they are making active decisions.
“You would not expect much diversity in returns between the Hare and Tortoise in this sector. It is typical for investors to take a buy-and-hold strategy to fixed interest, and therefore the net cash flow to this sector is muted in comparison to other sectors, at less than 0.5 per cent of FUM per quarter on average, so the Hare isn’t making large additional investments or divestments,” Keown says.
International fixed interest
A buy-and-hold strategy is typical here too, according to Keown, with net cash flow changes in the international fixed interest category at only 0.13 per cent of FUM per quarter on average.
The platform Hare and wholesale Hare outperformed the Tortoise in all three periods on a simple compound return basis, and significantly so, indicating that the timing decisions it made “paid large dividends”.
The pure retail Tortoise was again considerably ahead of the pure retail Hare in the asset class on a simple compound basis.
However, on a rolling average basis over the three periods, the platform Hare and Tortoise again achieved similar results, as did the wholesale Hare and Tortoise, meaning the Tortoise was more likely to come out ahead after fees.
An exception was the pure retail Hare’s outperformance of the pure retail Tortoise on rolling returns, although this was described by Keown as an “interesting anomaly” to the rule and something that will be the subject of further analysis.
