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SQM Research Ratings Update
April 2020
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Our Ratings & Fund Data Service covers Sector Reviews, Fund research & Quantitative analysis for about 9000 funds. For more information contact us today! Get the right information & insightful advice first from SQM Research. To subscribe to our Ratings and Funds Data Service, click HERE.
The CPI + 5.0% Challenge
Rob da Silva – Head of Research
In our February newsletter we talked about CPI + 5% as a fairly commonplace goal used by advisers and fund managers. In this note we take a quick look at how that goal relates to the multi-asset category of funds.
We will start by looking at how well multi-asset funds have done against the CPI + 5%
In a decade when beta was king and buying just about any asset class got you good returns, multi-asset funds did okay. Just under 50% of funds beat CPI + 5% over 3 years (to Dec-19) and 30 to 35% beat this mark over 10 and 5 years.
Fast forward a mere 3 months and see what damage the virus has wrought. Less than 3% of funds beat CPI + 5% over 3 years (to Mar-20), less than 1.5% over 5 years and less than 7% over 10 years.
Another perspective that shows how CPI + 5% is a big challenge, is to compare it to traditional markets. See the table below.
These returns are sorted from highest to lowest on the 20-year return column. In this list, RBA Cash Rate + 5% and 4% are No.1and 2. Recall from our last note the history of real cash rates and how they were strongly positive in the three decades leading up to the GFC. Real cash rates averaged 4.70% over that time, with a maximum of 12.7% and a minimum of 1.5%. Add 4 or 5% to that and you are up there with the best.
CPI + 5% shows an extraordinarily strong result, placing 3rd in the list. To beat this as a benchmark, you have got to have techniques and processes that add considerable value to the traditional “beta” building blocks used in investment portfolios. It is not an easy task.
Let’s take a deeper dive.
We start by identifying how many funds use a CPI-related investment objective.
Of the 10,155 funds in the SQM database, the distribution is:
So just under 30% of Multi-Asset funds have a CPI-related benchmark. We are going to further examine the subset of funds that have at least a 5-year track record. This brings the fund count down from 899 to 653, with a total FUM of $597 billion.
The table below shows the number of funds by benchmark. CPI + 4.5% and CPI + 5.0% are clear favourites covering almost 40% of these funds.
The table below summarises the alpha achieved by these 653 funds as measured against their own official CPI-related benchmark.
Results to Dec-2019 show on average 97.7% of funds best their benchmark over 1 year, 49.9% over 3 years and 36.6% over 5 years. 2019 was a good year.
Again, an additional quarter makes a monumental difference. The table below shows results for the same funds through to Mar-2020. A complete turnaround. Virtually no funds (0.2%) beat their benchmark over 1 year, a mere 6.4% for 3 years and 7% for 5 years. There is red-ink all over this table.
It should be noted that this massive correction likely sets the scene for a higher possibility of meeting benchmarks over the next three to five years. Why?
- CPI is likely to be lower – there is the possibility of outright deflation over the next 6 months or so and ongoing low inflation due to weak aggregate consumer demand and plummeting oil prices. Talk of an inflation spike caused by massive fiscal injections and QE seems premature. The fiscal injections are not a stimulus – they are a (partial) replacement for lost income and activity due to virus-induced economic shutdowns. Also, rock-bottom interest rates and massive QE have not sparked inflation in other developed countries over the last 5 years. Coming out of the shutdowns it is likely that consumer confidence will remain fragile, labour markets will take years to regain their former levels of employment and, post a short re-bound period, ongoing average economic growth will likely be lower than it was prior to the pandemic.
- Risky beta is much cheaper than it was – providing some scope for better returns (relative to CPI) in the future as markets recover.
Finally, an observation about the prior two tables. There is a tendency for average alpha to decline as the targeted CPI margin increases. This is particularly true for the 3 and 5 year columns in both tables.
This might make intuitive sense – a higher hurdle is more difficult to achieve and so a higher failure rate should be expected.
Except that the hurdle rate is set by the managers themselves, not by an external third party. It is rational to expect that managers set themselves a goal they believe they can achieve knowing better than anyone else about their capabilities – staff, investment philosophy and style, risk tolerance and many other ingredients to investment success.
Consequently, the rational average alpha expected by managers in aggregate should at least be a positive number (preferably net of fees). The data presented in this note is not supportive of that theory.
There are many possible explanations for these results. It may well be that managers overestimate the level of their own skill and set their objectives too high as a result. There is behavioural finance research that is consistent with that idea. Others would argue that it shows that active management doesn’t work
At SQM Research, we believe in the value of active management and feel these results show that active management is difficult, not impossible. True active alpha exists (unlike unicorns) but it is a scarce commodity that is difficult to identify and challenging to extract.
The two charts below are very sharp illustrations of the effect. A significant negative relationship between higher targeted CPI margins and actual alpha outcomes. The red dots represent negative alpha. The tightness of the relationship is particularly strong in the Mar-2020 figures, with a correlation of 92%. The Dec-2019 figures show a still material correlation of 66%.
Fees and costs are a very important consideration in this discussion.
The Multi-Asset category has relative high fees and cost as represented by average ICRs and MERs.
The chart below the distribution of ICRs across multi-asset funds. 50% of the funds have an ICR ranging from 1.51% to 2.57%. These types of charges have a significant impact on the net-of-fee alpha statistics detailed in this note.
SQM Research rates a number of multi-asset funds in a segment that has been growing materially for us in the last 12 months.
Our higher-rated funds with a 5 year or longer track record have performed well relative to the broad universe, as the table below shows.
Recently Published Reports
Discontinued or Not Renewed
SQM Research's Top 5 SQM Rated Funds* - 31 March 2020
Click here to enlarge
* Any Funds in this table that have international investments will have different hedging patterns, from hedged to unhedged or variable hedging. This may have an impact on fund returns. Please refer to the Fund's product disclosure statement for details.
SQM Research's Top 50 ETFs - 31 March 2020
(Please note: In order to view individual ratings reports you must be subscribed to SQM Research Ratings research. To subscribe, click HERE)
For further information:
Rob da Silva - Head of Research, SQM Research
Tel: (02) 9220 4606 Email: rob@sqmresearch.com.au
Louis Christopher - Managing Director, SQM Research
Tel: (02) 9220 4666 Email: louis@sqmresearch.com.au
About SQM Research
SQM Research is an independent property advisory, ratings and forecasting research house which specialises in providing accurate property related advice, research and data to financial institutions, property developers and real estate investors. For more information please visit www.sqmresearch.com.au
Research Methodology
In general, the assessment approach adopted by SQM Research incorporates a combination of qualitative and quantitative research techniques to assess property investment products. Information generated is passed through the SQM Research assessment model at the completion of the assessment process. The assessment model generates a product score, which correlates to a specific star rating (out of a maximum of five stars). Each star rating covers a scoring range, allowing products to be ranked within quarter star increments.
Following are descriptions for each of the star ratings, which have been developed as a guide for dealer group research teams and investment committees:
4.5 stars and above - Outstanding. Highly suitable for inclusion on APLs.
4.25 stars - Superior. Suitable for inclusion on most APLs.
4 stars - Superior. Suitable for inclusion on most APLs.
3.75 stars - Favourable. Consider for APL inclusion.
3.5 stars - Acceptable. Consider for APL inclusion.
3.25 stars - Caution required. Not suitable for APLs.
3 stars - Strong caution required. Not suitable for APLs.
Below 3 stars – Avoid or redeem. Not suitable for APLs.
Hold - Rating is suspended until SQM Research receives further information. A rating is typically put on hold for a period of two days to four weeks.
Withdrawn - Rating no longer applies. Significant issues have arisen since the last report date. Investors should consider avoiding or redeeming units in the fund..
* The definitions above are not all encompassing and not all individual items mentioned will necessarily be relevant to the rated Fund. Users should read the current rating report for a comprehensive assessment.
DISCLAIMER
The rating contained in this document is issued by SQM Research Pty Ltd ABN 93 122 592 036. SQM Research is an investment research firm that undertakes research on investment products exclusively for its wholesale clients, utilising a proprietary review and star rating system. The SQM Research star rating system is of a general nature and does not take into account the particular circumstances or needs of any specific person. The rating may be subject to change at any time. Only licensed financial advisers may use the SQM Research star rating system in determining whether an investment is appropriate to a person’s particular circumstances or needs. You should read the product disclosure statement and consult a licensed financial adviser before making an investment decision in relation to this investment product. SQM Research receives a fee from the Fund Manager for the research and rating of the managed investment scheme.
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