For financial advisers and professional investors only – not for distribution to retail investors.
July 17 2024
By Derek Bliney
Key Insights
- Consistent active performance is highly valued by advisors looking to allocate over long periods, freeing up resources for more value-adding activities.
- A durable stock-selection model combined with a strong understanding of multiple risk dimensions is essential for delivering consistent active returns through the cycle
- Assessing a manager's performance in both positive and negative markets provides insights into the consistency of investment performance.
Investors appreciate managers who can deliver consistent active returns across market cycles. Consistent performance can mitigate timing risk – the risk of chasing performance and switching managers at inopportune times. It also reduces costs associated with identifying, researching, and transitioning between managers. Additionally, consistent performance simplifies conversations with clients – allowing time to focus more on understanding their needs rather than explaining poor performance.
Managers who demonstrate consistent performance are ideal candidates for core allocations that can be supplemented by strategic allocations to more style or thematic-driven tilts.
What does ‘consistent performance’ mean?
There is no single agreed-upon definition of investment consistency. The Information Ratio (active returns divided by the standard deviation of active returns) is a useful starting point but can disproportionately reward passive strategies.
Generally, consistent investment performance is observed when a portfolio outperforms under various market conditions over multiple time periods. Identifying consistent performance involves more nuance than merely examining the ‘best’ performing manager over a long horizon. Many managers start strong when their Funds Under Management (FUM) is small, allowing for nimble repositioning and benefiting from a few fortunate bets or an opportunistic IPO allocation. This initial outperformance can distort performance records and does not reflect the returns received by subsequent investors.
Consistent active performance is delivered when a fund outperforms the benchmark despite:
- Swings in market direction (i.e., ‘Up-markets’ vs ‘Down-markets’)
- Investment style performance variability (i.e., ‘Value’ vs ‘Growth’ vs ‘Quality’ driven markets)
- Sector or size performance variability (i.e., ‘Large-caps’ vs ‘Small-caps’ or ‘Banks’ vs ‘Resources’)
- Variability due to positive and negative stock-specific events (i.e., ‘takeovers,’ ‘profit-downgrades’)
Given the myriad of factors that can derail performance, how can managers consistently outperform?
Alpha vs Risk trade-off
Few managers claim to outperform every single day, month, or even year. While it sounds appealing, such consistency is too much to expect from active management. However, over longer periods, managers who combine a robust stock-selection model with a strong focus on risk can consistently outperform. The key is to tilt portfolios toward a diversified set of investment characteristics that have historically outperformed while avoiding tilts to factors with variable and volatile performance.
For our investment approach, this means moderate active tilts to a mix of durable investment styles (such as Value, Sentiment, Quality-based characteristics as well as other proprietary investment signals) while remaining relatively neutral on less reliable sector, size, and market direction factors.
Variability due to stock-specific events often contributes to short term performance swings but tends to neutralise over the longer term. Position sizing that considers risk at the stock level and correlations between stocks can also reduce stock-specific risk.
What does consistency look like?
Consider a 12-month rolling window of active performance, starting in December 2017 (when the strategy switched to a systematic approach). From December 2017 to April 2024, there are 66 rolling 12-month windows. For the Macquarie Australian Shares Fund, 71% of these one-year periods resulted in outperformance relative to the benchmark. Not bad.
However, as noted earlier, one year is a short time to assess an active investment strategy. Instead, consider a three- or five-year window, reflecting a more realistic time horizon. In this scenario, 100% of three-year windows and 100% of five year-windows resulted in a relative outperformance. This is consistency in action.
Figure 1: Macquarie Australian Shares Fund: Percentage of positive rolling excess returns for each of the following periods
For the Macquarie Australian Small Companies Fund, the performance consistency is even more apparent. 92% of one-year windows resulted in a positive outcome. For three and five-year periods, 100% of rolling windows delivered positive active returns.
Figure 2: Macquarie Australian Small Companies Fund: Percentage of positive rolling excess returns for each of the following periods**
Past performance is not a reliable indicator of future performance. Current performance information for the Funds is available on our website at macquarie.com/mam/au-performance. Benchmark for the Fund is the S&P/ASX 200 and S&P/ASX Small Ordinaries respectfully. Outperformance of the Benchmark does not mean the Fund’s performance has always been positive. Equity markets can be volatile and have the potential to fall by large amounts over short periods of time. One year, three year and five year periods are measured on a monthly rolling basis starting 1 December 2017 to 30 April 2024. Using five year periods as an example, the first period was measured from 1 December 2017 to 30 November 2022, the second from 1 January 2018 to 31 December 2022 with each subsequent five year period starting one month later. The last five year period was measured from 1 May 2019 to 30 April 2024.
Up-markets vs Down-market performance
Using Morningstar performance data, we can compare performance in positive and negative markets, known as upside and downside capture. Ideally, a fund that delivers consistent active returns outperform in both rising (upside capture < 100%) and falling (downside capture > 100%) markets.
Figure 3 shows the upside and downside capture of 97 large-cap peers1 with track records back to December 2017. The four quadrants highlight the overall performance of a fund in positive (up) and negative (down) markets. Most managers either outperform in one direction and underperform in the other (north-west and south-east quadrant).
Some managers underperform in both up and down markets – ouch. But very few are able to outperform in both up and down markets and those who can are considered more consistent. The Macquarie Australian Shares Fund, indicated by the red marker, shows healthy outperformance in both conditions.
Figure 3: Upside and downside capture for Australian Large-cap strategics (Australian Shares Fund peers) December 2017 – April 2024
This tendency of funds to outperform or underperform depending on market direction is generally related to the beta of the fund relative to the benchmark. A fund with a beta significantly greater than 1 will likely outperform in positive markets and underperform in negative markets, whilst a fund with a beta significantly less than 1 will likely outperform in negative markets.
Our active equity strategies typically have betas close to 1, but due to the dual-focus on stock-selection and risk management, have a history of outperforming in both positive and negative markets.
Overall performance also needs consideration. From December 2017 to April 2024, the Macquarie Australian Shares Fund was ranked 3rd for overall performance across its peer set1. Consistency does not necessarily mean benchmark-like returns.
Consistent active performance is essential for building a resilient and reliable investment strategy. It can allow advisers to allocate resources more effectively, reduces the complexities and costs associated with manager transitions, and fosters more productive client interactions.
Our approach demonstrates that a well-balanced strategy with moderate active tilts and a focus on long-term performance can deliver returns. Ultimately, consistent active performers are ideal for core allocations in a broader asset allocation framework.
Footnotes:
1 Peer universe is defined as the Morningstar Australian Equity Large Blend universe. The Macquarie Australian Shares Fund performance from 1 December 2017 to 30 April 2024 was 10.24% net of fees. The Morningstar Equity Australian Large Blend funds invest primarily in large Australian companies. Stocks in the top 70% of the capitalisation of the Australian equities market are defined as large-cap. The blend style is assigned to portfolios where neither growth- nor value-characterised stocks dominate.
Past performance is not a reliable indicator of future performance. Up to date performance information for both funds referred to in this insight are available on our website at macquarie.com/mam/au-performance.
Author
Risks
All investments carry risk. Different investments carry different levels of risk, depending on the investment strategy and the underlying investments. Generally, the higher the potential return of an investment, the greater the risk. The risks of investing in the Funds include:
Macquarie Australian Shares Fund:
Investment risk: The Fund has exposure to share markets. The risk of an investment in the Fund is higher than an investment in a typical bank account or fixed income investment. Amounts distributed to unitholders may fluctuate, as may the Fund’s unit price. The unit price may vary by material amounts, even over short periods of time, including during the period between a redemption request or application for units being made and the time the redemption unit price or application unit price is calculated.
Market risk: Share markets can be and have been volatile, and have the potential to fall by large amounts over short periods of time. The investments of the Fund are likely to have a broad correlation with share markets in general, and hence poor performance or losses in domestic and/or global share markets are likely to negatively impact the overall performance of the Fund.
Security specific risk: Securities and the companies that issue them are exposed to a range of factors that affect their individual performance. These factors may cause an investment’s return to differ from that of the broader market. The Fund may therefore underperform the market and/or its peers due to its security specific exposures.
Macquarie Australian Small Companies Fund:
Investment risk: The Fund has exposure to share markets. The risk of an investment in the Fund is higher than an investment in a typical bank account or fixed income investment. Amounts distributed to unitholders may fluctuate, as may the Fund’s unit price. The unit price may vary by material amounts, even over short periods of time, including during the period between a redemption request or application for units being made and the time the redemption unit price or application unit price is calculated.
Market risk: Share markets can be and have been volatile, and have the potential to fall by large amounts over short periods of time. The investments of the Fund are likely to have a broad correlation with share markets in general, and hence poor performance or losses in domestic and/or global share markets are likely to negatively impact the overall performance of the Fund.
Small companies risk: The Fund has exposure to companies generally considered small to medium in terms of market capitalisation. Companies within this sector of the market may include recently established entities with limited public information, or entities engaged in new-to-market concepts which may be speculative in nature. Shares in companies in this sector are generally less liquid and more volatile than those of larger companies. Small companies exposure may result in higher unit price volatility and an increased risk of loss.
More information on the risks of investing in the Funds is contained in the Product Disclosure Statement of the relevant Fund, which should be considered before deciding to invest in the Fund.
The Macquarie Australian Shares Fund is designed for consumers who:
- are seeking capital growth and income distribution
- are intending to use the Fund as a core component, minor allocation or satellite allocation within a portfolio
- have a minimum investment timeframe of five years
- have a high or very high risk/return profile for that portion of their investment portfolio, and
- require the ability to have access to capital within one week of request.
The Macquarie Australian Small Companies Fund is designed for consumers who:
- are seeking capital growth and income distribution
- are intending to use the Fund as a minor allocation or satellite allocation within a portfolio
- have a minimum investment timeframe of five years
- have a very high risk/return profile for that portion of their investment portfolio, and
- require the ability to have access to capital within one week of request.
Important information: The Target Market Determination (TMD), available at macquarie.com/mam/tmd, includes a description of the class of consumers for whom the Fund is likely to be consistent with their objectives, financial situation and needs.
The Fund(s) mentioned above may have multiple classes of units on issue. A separate class of units is not a separate managed investment scheme.
This information has been prepared by Macquarie Investment Management Australia Limited (ABN 55 092 552 611 AFSL 238321) the issuer and responsible entity of the Fund(s) referred to above. This is general information only and does not take account of investment objectives, financial situation or needs of any person and before acting on this information, you should consider whether this information is appropriate for you. In deciding whether to acquire or continue to hold an investment in a Fund, an investor should consider the product disclosure statement for the relevant class of units in a Fund, if any, and the Website Disclosure Information available at macquarie.com/mam or by contacting us on 1800 814 523.
Nothing in this document constitutes a recommendation to buy, sell or hold any financial product, security or instrument.
Future results are impossible to predict. This document contains opinions, conclusions, estimates and other forward-looking statements which are, by their very nature, subject to various risks and uncertainties. Actual events or results may differ materially, positively or negatively, from those reflected or contemplated in such forward-looking statements.
Past performance information shown herein, is not a reliable indicator of future performance. No representation or warranty, express or implied, is made as to the suitability, accuracy, currency or completeness of the information, opinions and conclusions contained in this document. In preparing this document, reliance has been placed, without independent verification, on the accuracy and completeness of information available from external sources. To the maximum extent permitted by law, no member of the Macquarie Group nor its directors, employees or agents accept any liability for any loss arising from the use of this document, its contents or otherwise arising in connection with it.