Predictions that active managers would enjoy a better 2023, seem to be playing out in the Australian large capitalisation space, with the number who beat the benchmark S&P/ASX 200 in the first half of the year, better than historical levels.

S&P Global’s respected SPIVA Australia Scorecard, found that 45% of Australian Equity General Funds including open ended managed funds and exchange traded funds, beat the index in the six months to June 30.

“The S&P/ASX 200 gained 4.5% in the first half of 2023, while on average, Australian Equity General funds rose 4.6% on an equal-weighted basis and 4.7% on an asset-weighted basis,” wrote S&P analysts in their mid-year update.

While not necessarily sufficient to sway ardent believers in passive investing, the results are nonetheless better than the long term track record of funds in this category. In the five years to the same date, only 19% were able to beat the index and hence fulfil the essential proposition of active management.

Australian equity mid- and small-cap funds appeared more able than their large-cap cousins to meet this objective, with a small majority (52%) doing better than the benchmark in the first half of the year and just over a third (36%) outperforming over five years.

Post-GFC woes

Much was made earlier this year of the potential for active equity managers to regain their mojo after a challenging period. Financial firm Mercer added its voice to the debate, by suggesting that March last year had marked the trough of equity active management performance, with the median manager in its global equity universe bouncing back significantly in the subsequent 12-months.

“It is increasingly evident that the Global Financial Crisis (GFC) era when interest rates were anchored at historically low levels for more than a decade created distortions in the market,” Mercer’s team wrote in After the Perfect Storm – Active Management Recovers.

Examples of market distortions driven by the availability of cheap capital include the outperformance of speculative companies, further increases in multiples of high-quality companies (‘growth at any price’) and the survival of highly leveraged companies which may have otherwise gone out of business.

“While rising rates usually create a headwind for investment returns on an absolute basis,  the simple fact that they have risen, has reintroduced a tangible opportunity cost that has been absent in financial markets for most of the post-GFC era,” wrote Mercer.

“If the distortions incentivising the ‘borrow to buy-back’ and ‘growth at any price’ regimes have run their course, the market concentration seen in the latter half of the previous cycle is unlikely to repeat in the coming years. This should lead to increased dispersion in stock returns, thereby likely creating a supportive environment for active management.”

Beyond Aussie equities

So far, the outperformance of active global equity funds available to Australian investors doesn’t appear to have rebounded to the same degree as local share funds. The SPIVA Australia Scorecard shows that only 26% outperformed the S&P Developed Ex-Australia LargeMidCap index in the first six months of the year. 

This benchmark gained 18.1% over that period, while International Equity General funds gained 16.1% and 14.8% on equal and asset-weighted basis, respectively.

Again, the underperformance rate increased over longer periods, with only 9% of funds in the category out-pacing the benchmark in the five years to June 30.

Mercer suggests several principles can be applied to navigating these apparent ups and downs to optimise investments in managed funds, without getting caught up in the debate about whether active management overall is worth it. These principles are:

• Only invest actively in markets where it is appropriate, and when it is aligned with an investors’ objectives
• Focus on building robust equity portfolios that are exposed to a diversified range of return drivers
• Ensure unintended total portfolio exposures and unrewarded risk are appropriately managed
• Review manager performance to ensure it is in line with expectations.

This appears a sensible approach in a continued environment, in which the ability of active managers to meet their stated goals over the long term, remains variable across geographies and sectors.