Is 'Best in Show' for you?

Jonathan Ramsay
Jonathan Ramsay
InvestSense Director
This week we cover the apparently dismal performance of active managers and the Productivity Commission's proposed 'Best in Show' policy.

There has been quite a lot in the mainstream media recently about two related topics:

  1. The apparently dismal performance of active managers; and
  2. The Productivity Commission's 'Best in Show' proposal.
The atmosphere created by the Royal Commission is an accelerant, and it is quite understandable that you may have concerns. However, we think the implications are much more nuanced and the switching that this could provoke may well prove to be a classic wealth destruction trap for hapless retail investors.

This may well undermine the industry’s credibility if, as is becoming likely, we see an environment of institutionally driven performance chasing. On the other hand, this dynamic may well, eventually, provide an opportunity for investors to understand the value of conviction based, forward-looking fundamental analysis.

In summary:

  • In last week’s AFR we saw support for the 'Best in Show' concept from an unlikely quarter in BT Financial. Remember though that BT is no longer a fund manager and this positioning will curry favour with Westpac’s arch-antagonists of the moment - the various regulators and ‘commissions’. To recap, this is the idea that super money should, by default, be directed to the 10 of the ‘best-performing’ superannuation funds.

  • Notwithstanding the drawbacks of the commission-based structure we are emerging from, most fund managers and advisers find the idea odd to say the very least. A recipe for wholesale wealth destruction at the worst. Managing money is hard and no technique, edge, or approach, no matter how clever, works forever. However, one maxim has proved enduring - past performance is a poor guide to future performance. 

  • Most things in markets turn out to be cyclical in the end, but often only after every market participants’ conviction has been truly tested. So it is really no surprise that those who were the backstay of the ‘performance is no guide to the future’ mantra (the prudential regulators) will probably end up being the same ones that send the masses on an epic past performance binge. To paraphrase another old market saying: the cycle will only turn when the strongest hand folds.

  • In practice, this means that the three primary drivers of relative performance since the GFC - leverage, illiquidity, and index momentum - might get a last hurrah. Another writer in the AFR writes very eloquently on this potential ‘cycle within cycles’. However, where we disagree slightly with that writer is that Australian investors are, by and large, price takers and a pimple on global flows of capital (some domestic assets aside given the size of our superannuation system). That implies that the bubbles in debt, illiquid assets, beneficiaries of passive flows, and especially industry funds, could well burst before 'Best in Show' actually happens.

  • For investors who are happy to lean against these trends with confidence based on fundamental analysis, we think there is an opportunity to be on the right side of this reversal. This could prove right either in the short term or very right in the long term. But it may also feel very wrong for a little while or for a long time.

Over the next three weeks, we will substantiate this view by answering three questions that we think will have a bearing on this emerging polemic, specifically addressing why the next ten years has to be very different from the past ten years:

  1. Why is chasing past performance the overarching nemesis of the retail investor?

  2. Is the shift to passive investments a one-way journey or might active managers still have the last laugh?

  3. Do scale and the ability to invest in illiquid investments really infer a long-term structural advantage in markets for industry funds?

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