The Messenger: Don’t get left out in a cold market

A question of indexing

The level of debate about indexing is low.

Indexing makes most sense in asset classes such as listed property and bonds, where it is rare to materially outperform or underperform — at least once funds under management (FUM) become substantial. There is very strong clustering around index returns.

Divergence from an index is much greater in equities, so the prima facie case for active management is much stronger.

Efficient market theorists argue that the average equity manager won’t add value. Generally, I accept this and draw the logical conclusion — there is little point in investing in the average active manager.

In truth, many institutions are more interested in not diverging excessively than in attempting to outperform.

However, efficiency advocates find their way to a quite illogical conclusion: the fact that the average manager will not outperform means that no manager will.

Setting this proposition out in logical terms: the average score of a sample is around a particular norm; therefore every individual score is around the norm. It is statistical bunkum.

Take an analogy. The average temperature on the globe on any day is in the temperate range. Therefore, according to efficiency advocates, no place is very hot or cold.

Anyone who accepts this argument should sit outside in an Alaskan winter and re-consider their position.

Those who believe no-one can consistently beat a market (and its amusing corollary — no-one can fail to match it) need to explain the inconvenient fact that, at any point in time, some managers will have done better and some will have done worse.

Over the short-term, chance will have influenced this. It is much more difficult to explain away sustained superior returns as luck.

For years I have tabled the performance of Kerr Nielsen and his team as a demonstration of superior skill. Hardline efficiency junkies pass this off as, in principle, unsustainable. My response is that they argued this years ago and, lo and behold, it has been sustained.

If they remain superior for, say, the next five years, can we consider the debate closed?

Of course, the focus should be on the performance of individual managers, not the institution’s name. The track record of this group predates Platinum and harks back to BT’s golden era. When key individuals leave a manager it is perfectly sensible to consider doing likewise.

The other strange position frequently heard is that indexing removes risk.

When the meaning of the word ‘risk’ in this context is analysed it proves to mean the risk of diverging from an index. One must readily grant the way to match an index is to invest in an index. All tautologies are true.

However, it escapes me how this could be described as low risk. What was safe about matching the decline of the MSCI during the collapse of the tech boom?

Anyone who believes that minimising this decline was riskier than suffering it fully has lost touch with clients’ psychology.

Property syndicates under pressure

A number of property syndicates are currently floating proposals to extend their terms. This is not a surprise.

Few managers will willingly pay out FUM. I predict a large proportion of syndicates will not be wound up at their term. Extension, merger, listing and other options will be recommended to investors to ensure the assets are retained.

Extension proposals often point out that the costs in selling the properties and winding up the fund will not be incurred if it is extended.

It is perhaps a little late for investors to focus on this now. It should have been considered before they went in. The reality is that these costs will hit whenever the fund terminates.

One of the weaknesses of syndicates compared to listed property is that investors bear the cost of both establishing and finalising a fund, and buying and selling property.

These add up to a considerable proportion of investors’ capital, especially if GST is involved (and stamp duty, particularly in NSW), and the more the fund is geared, the larger the slice.

The only ways to avoid these costs are to list or to never terminate.

One of the main (purported) arguments for syndicates is that they are not listed, so floating them on the stock exchange would be a turn-around.

Nonetheless it will not surprise me if it should occur. This may be most likely if funds terminate during a property collapse. Remember unlisted property trusts?

While real estate is buoyant, promoters can terminate a fund but offer a new one to reinvest in as a means to retain the assets. Retention pressure will be higher in a poor market.

Some syndicates currently being restructured do give individuals a redemption option.

Others, with an inferior structure, can have this decision made by the majority of unit holders.

Making access to one’s own money subject to a democratic vote relinquishes control to strangers.

Of those current restructures allowing an individual redemption option, some have said that if any one person wants to be redeemed, all will be. And bad luck if you want to stay in.

Robert Keavney is chief executive officer of Centrestone Wealth Advisory .