Kernel's Dean Anderson, who manages index funds, takes a critical look at the performance of his rivals, active fund managers, as everyone battles through the markets in a pandemic

Kernel's Dean Anderson, who manages index funds, takes a critical look at the performance of his rivals, active fund managers, as everyone battles through the markets in a pandemic

This is a repost of an article by Kernel, an index investing platform. It is here with permission.


Warren Buffett famously said that “when the tide goes out, you’ll see who’s been swimming naked”. Right now, active fund managers are high and dry.

Active fund managers have long defended their high fees and underperformance by stating their value will be proven in the event of a correction or crash. You see, active managers claim their research and close scrutiny of the market equips them with the foresight to shift portfolios appropriately. However, the opposite is proving true as markets around the world plummet.

Generally, research indicates that between 50-70 per cent of active funds will underperform their relevant index benchmark in any given year. If you are considering a long-term investment, you should be even more concerned by the performance of active fund managers over the past decade. CNBC reported that 9 out of 10 failed to outperform their relevant index benchmark across most major markets.

This shows that even the 1 in 10 active managers who outperformed, probably did so more as a matter of good fortune, rather than of skill. Active fund managers assure us that in times of distress, high risk and falling markets, they have the tools and smarts to protect investors and their funds.

Predictions are hard, especially about the future

The above was said famously by physicist Niels Bohr. However, we could argue that the COVID-19 pandemic was a highly observable event. There were early warnings, then strong signals, first from China, then from Europe, that this was likely to affect New Zealand’s economy.

By mid-March it was clear major disruption was looming and of course we’re now locked down. So did active managers use the warning signs to their advantage? Did their foresight enable them to protect their customers’ portfolios against the rapid downturn?

Let’s take a look at some results

In the first quarter, markets rapidly followed global and local news and moved from highs into bear territory. What the quarter-end data (which is reported directly from fund managers themselves, including us) shows is:

  • 14 out of 15 New Zealand equity funds underperformed Kernel’s NZ 20 index fund. Let’s just focus on that for a second – 93% of New Zealand active equity funds underperformed Kernel’s NZ 20 fund in the March quarter.
  • The average active fund dropped 13.6% – 30% more than our NZ 20 index fund, which dropped 10.5%.

For Commercial Property funds, things did not fare much better:

  • Our Commercial Property index fund outperformed every large listed real estate active fund, beating our nearest equivalent by 1% and again on average by over 3% (net of fees).

What about the trans-Tasman funds?

  • While only 6 out of 10 trans-Tasman active funds (those which invest across New Zealand and Australian shares) underperformed a 50/50 trans-Tasman index, Kernel’s NZ 20 index fund outperformed 21 out of 23 of them.

Whie we acknowledge that in any one year, some active managers can outperform their benchmark, it’s highly unlikely that this can be repeated year on year with assured consistency.

So here’s the bottom line

The numbers don’t lie. Active managers are no more skilled at protecting your investment in a downturn than they are at adding value when the market is rising.

If active managers cannot deliver out-performance over the long term, you have to question what – if any – value they are adding.

This is a repost of an article by Kernel, an index investing platform. It is here as part of a range of views. We welcome an active manager's view.

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I am happy with one of the banks growth investment fund (non kiwi-saver) doing fairly well during this downturn.
Not sure how far this model works in near future!!

Have you looked at Robert Shiller's CAPE modelling?

Yes indeed. The returns are not going to be great at least for a decade, as this one is BIGGER than Great Recession.

Dean, given brokerage costs, custody costs and management fees (for managed funds)are all pretty horrific here in NZ do you see any mechanism/steps through which more cost effective direct investment can take place ?

I'm interested as the focus on residential property here is somewhat a function of low choice, poor liquidity and high cost in the capital markets, and without this changing I can't see our reliance/preference for investing in housing being diluted.

Historically the argument by all of the suppliers in the chain has been the small scale of the NZ market. However it isn't a scale problem, it is their legacy technology being inefficient and unable to deliver cost effective and customer focused outcomes. Ultimately, implementation of new technology, by participants like Kernel and existing service providers, is the key to reducing investor costs.

I'd argue that social and demographic changes are already resulting in a shift away from property (both investment and owner occupied) and into the capital markets. This is particularly noticeable for sub baby-boomer generations - less DIY mantra, lifestyles revolving around experiences, digital natives, higher disposable incomes but lower net worth (i.e. deposit hurdles are daunting).

With a medium amount of scale, I believe opportunities for direct investment are already fine.

Fee's with ASB are $30 for NZ share purchases up to $10k, and $90 for International purchases of $10k, so between 0.3% and 0.9%. A bit of a hit, but most funds charge more than that annually.

Having $200k across various stocks purchased in $10k blocks, doesn't give me the diversity a lot of funds do, but as time goes on diversity can be baked in. The fun bit is that I get to choose when to be active (not often, but some extra money made this way).

Suprised more people don't invest directly once they get a little bit of scale!

If you're comparing an NZ-only index to active managers, you need to compare it to NZ-only active managers.
Quay Street (linked below) is an active management fund that is mainly NZ equities (when I last checked) and they have outperformed your index.

Apples to apples if you're writing an article like this please. [ Insult deleted. Not needed. Ed. ]

Appropriate benchmarking and apples for apples comparisons is critical and if you read the piece you will note that I made it clear that this was an assessment of active NZ equity only funds vs the NZ 20 index fund, after fees and before tax. All data was sourced from Morningstar.

You are correct, the one NZ equity fund (out of 15) that performed better during Q1 than the NZ 20 index fund was that fund, as it had been holding 30% cash before the quarter.

Dean, Would you please post the web address(es) where we can find the performance of the active NZ equity-only funds to whose performance you are comparing the index fund? Could you also list the funds? You say "If active managers cannot deliver out-performance over the long term, you have to question what – if any – value they are adding". But how do you measure their performance? If it is it after fees then it is unreasonable to expect them to add value. They have to only match the market, not outperform it as their fees have been taken out of play be being subtracted from their performance. You would be in effect double counting their fees.

You can filter for NZ equity funds through Morningstar, which uses the performance data supplied by fund managers.

Every fund manager also publishes their performance on their website, but it can take a few weeks for some to have it loaded.

Performance is measured net of fees i.e what the investor receives in the hand. Active management should expected to deliver more than an investor would receive if they invested in an index fund net of fees. This is what we were testing.

The only way to be an active manager that consistently outperforms an index is to own 100% of a business and make all the important decisions yourself.

Why is giving a platform to a commercial entity pushing its own views. Sponsored content tag please, or else it’s all the ‘news’ that’s free to publish.

I guess there are all sorts of prophets to watch, Warren being just one, and if so his creed of :

"Be fearful when others are greedy and greedy when others are fearful,"

seems to have come to an end?

With this being the case, you would think that the CEO of Berkshire Hathaway would have been busy buying stocks over the past few weeks. According to SEC filings, though, this does not appear to be the case. .... it looks as if Buffett has been a net seller, not a buyer of stocks.

What are we to make of that?
"Sell, everything!" would be a good active investors' start! It's still not too late.