The Up-Again Down-Again Managed Fund Ride

By Mary Holm

Monday 19th March 2001

In sport, the most likely winner of an event is frequently the person who won last time. Not so with managed funds. Last year's top performing fund will often do badly this year.

It's not a good idea, then, to choose a unit trust, super scheme or other managed fund on the basis of how well it has done recently.

Much research has shown this. A recent example comes from Aon Consulting, which keeps track of New Zealand fund managers.

"Those managers who did well in 1998 and 1999 didn't fare too well in 2000, and vice versa," says Aon.

Of the 13 managers it looked at, none had returns in the top half for all three years. That's pretty amazing. Nobody even performed above average for three years.

What's more, eight managers appeared in the top quarter at least once and in the bottom quarter at least once. They were all over the place. If a fund is good, why doesn't it stay good?

Probably largely because there's more luck in managers' performances than many will admit.

One manager might favour small companies over large. Another, New Zealand shares over international. A third, "value" shares (basically cheap ones) over "growth" shares (ones that look likely to grow fast).

They will all come up with good reasons for their choices.

The fact is, though, that small, New Zealand and value shares do better than large, international and growth shares only in some years. And nobody knows, in advance, which years.

Aon tells us of two fund's changing fortunes.

"Tower's 'Value' style and underweight exposure to overseas equities had hurt them in the period up to March 2000. Since then, the change is dramatic and they have come up to second place in this survey for their Discretionary fund."

Colonial First State Investment, "with its 'very active' style (not constrained to value or growth) came in with the best return" in 2000, up from twelfth - almost bottom - in 1999.

Whatever their style, the funds that swing from top to bottom to top are also likely to go for riskier shares.

As we all know, the higher the risk, the higher the expected return. But high risk also means high volatility. And volatile shares or share funds tend to do spectacularly badly as well as spectacularly well.

The up-again down-again nature of returns on managed funds is one reason I favour index funds.

These funds invest in the shares in a share market index, such as the NZSE40 or the MSCI, which keeps track of the fortunes of the world's biggest companies.

An index fund performs as well or as badly as the portion of the share market covered by the index.

This sounds boring to many investors. They prefer active funds, like those described above, in which the managers try to perform better than the market.

If the managers succeeded more often than not, their funds would clearly be better than index funds. But, as Aon's research suggests, most active funds don't continue to excel.

What's more, index funds are much cheaper to run, because nobody needs to do research into which shares to buy and sell. So their fees are lower. In New Zealand, too, index funds don't have to pay tax on capital gains, but active funds do.

By the time you take tax and fees into account, only the occasional active fund does better than a comparable index fund over a decade or more.

And you'd have to be pretty lucky to pick that rare fund in advance.

Mary Holm is a freelance journalist and author of "Investing Made Simple", commissioned by the New Zealand Stock Exchange to write an independent personal investment column. She can be reached by E-mail at maryh@journalist.com. Sorry, but she cannot respond directly to readers.

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