Everything you must know before you refinance: https://www.prosolution.com.au/ebook/
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Share markets have been highly volatile over the past couple of years. Markets fell by circa 30% when Covid hit in March 2020 and then proceeded to boom until the end of 2021, fuelled by government stimulus and zero interest rates. However, markets fell by circa 20% in 2022 after central banks aggressively hiked rates. It’s been a wild ride.
Arguably, these large volatility events should have made it a lot easier for active fund managers to beat the index. Share market mispricing, overreactions and volatility should create profitable opportunities for active managers. I wanted to investigate whether this was the case.
What is an active manager?
An active manager picks a basket of stocks that they believe will generate high investment returns. Active managers can achieve that using two primary methodologies. They can try to identify undervalued stocks on the hope that their market value eventually rises to what they believe is fair value (that is called a value manager). Alternatively, they can identify companies that are likely to generate a lot of growth in the future, with less focus on whether they are fairly valued (that is called a growth manager). The truth is that there are lots of different strategies that active managers use, and it could be a combination of value and growth.
Because active fund managers need to employ a portfolio management team, they typically charge management fees of around 1% p.a.
What is an index fund?
Traditionally, an index fund invests in an index of the most valuable companies. For example, A200 is the lowest-cost Australian market index fund – it charges an investment fee of only 0.04% p.a. (e.g., fee on $100k invested is only $40 p.a.). It invests in the ASX 200 index which is the most valuable 200 companies listed on the ASX.
For example, the total value of the largest 200 companies is $2.1 trillion. BHP’s value (market capitalisation) is circa $240 billion, being approximately 11% of the total index – Australia’s most valuable company. Therefore, if you invest in A200, 11% of your money will be invested in BHP. 7.8% in CBA. 6.5% in CSL and so on.
An index fund is simply a managed fund that invests in a very broad basket of companies. The manager uses a rules-based approach for determining which stocks are included in that basket and how much to invest in each, such as the ASX 200. Because it uses a rules-based approach, it doesn’t need to employ costly portfolio managers and as such, the fees charged by index funds are very low.
What happened last year?
As I said in my opening paragraph, large movements in share markets caused by one or two major external factors often create obvious investment opportunities. Theoretically, active managers should be able to exploit these opportunities to generate higher returns. Therefore, I thought it would be interesting to investigate how active managed funds performed over the 2022 calendar year.
The table below shows that less than half of active managers beat the index in the 2022 calendar year. Only one quarter of active managers in the US and one-third of Australian managers have beaten the market over the past 3 years (i.e., the volatile covid period).
Proportion of active funds that outperformed the index
| | 1 year | 3 years | 5 years | 10 years | 15 years
| US Market | 48.92% | 25.73% | 13.49% | 8.59% | 6.60%
| Australian Market | 42.44% | 34.68% | 18.82% | 21.78% | 16.43%
Source: SPIVA
Longer term results are ev
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