Heads industry funds win, tails everyone else loses?

Jonathan Ramsay
Jonathan Ramsay
InvestSense Director
Last year, when we did some analysis of why industry funds had performed so well, it looked to be due largely to asset allocation. Higher allocation to risky growth assets equals higher returns in a bull market.

Then, markets fell, and they outperformed everyone else by an even greater margin!

What gives? It seems like the dog just keeps eating our collective homework. 

It turns out that the latest bout of volatility forces us to take a good look at the risk profile of illiquid growth assets. 

More risk, more return

The above chart is the one that we put together last year showing Financial Year 2017-18 performance against the growth/defensive split of assets for various industry and retail funds. 

Very strong equity markets, particularly in late 2017 and towards the end of the financial year, meant that funds with very high allocations to growth assets performed very well. 

This includes many of the well-known industry funds (red dots), but it’s a mixed picture with red dots and blue dots (retail funds) spread up and down the implied risk spectrum. 

Less mixed is the clear relationship between returns and allocation to growth assets. 

More return, less risk

Given our use of the words ‘implied risk’, you could be forgiven for thinking that if markets fell, risky funds loaded with growth assets would underperform. However, markets did fall precipitously in the last quarter of 2018 and many of those funds continued to outperform. 

Looking at the full picture of the year, the relationship has become exceptionally fuzzy. What is clear is that there is something going on.

More risk with ... less risk, and more return?

If we look at the same chart, but we substitute growth assets for illiquid assets, we see a clearer relationship - one that differentiates between retail funds (which tend not hold any illiquid assets) and industry funds (which tend to have substantial allocations to illiquid assets).

In short, 2018 was a year where THE winning strategy was holding illiquid growth assets.
So, why don’t retail funds adopt this strategy? Because they lack imagination? Or could it be that they have risk management processes, systems, and constraints in place that preclude such investments? 

Industry funds maintain that their stable and growing client base allows for such an illiquidity mismatch. That’s the difference between promising investors that they can have their money back within days and holding investments that wouldn’t allow this to happen. 

This sounds okay in theory but, as many people learnt during the GFC, practice can overturn theory very quickly in a crisis scenario. It’s probably that scenario that preoccupies the funds that don’t hold illiquid assets. 

In the comings weeks we’ll explore some of the risks associated with illiquid allocations as well as the attributes of the underlying investments in the current economic environment. 

In the meantime, a sound bite for those wondering why industry funds have performed so well might go as follows: “while diversification is often said to be the only free lunch left in investing, it’s also true that in markets you rarely get ‘nowt for nowt’”. 

A war-weary Greek might also suggest looking certain gift horses carefully in the mouth … which is just what we intend to do in the coming weeks.

A useful article, thanks

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