Investor momentum towards high conviction Australian equity strategies is likely to continue as traditional core strategies come under increasing pressure from low cost quantitative and passive index offerings, according to Zenith’s latest Research Report on the asset class.
In the past 12 months the research house has reported 24% growth in the funds under management of its rated Australian equity high conviction funds; concentrated, benchmark unaware strategies that target returns significantly higher than the benchmark. Conversely, the funds under management of core funds in its rated universe has declined 4%. Despite the decline, core remains the dominant style among Zenith’s rated fund managers.
Zenith’s Head of Equities, Quan Nguyen, states that “the investor-led shift towards high conviction funds and separately managed accounts reflects an increasingly sophisticated investor base expecting greater excess returns for their active fees. Fund managers are naturally responding to this heightened demand by offering more of these products.”
Over the past year, several fund managers in the core space have restructured teams and long-standing investment strategies. Some have even decided to wind up their businesses. Zenith believes that managers are required to bring to market products that are differentiated from the norm to remain relevant in today’s competitive market.
Zenith expects this trend to gain further momentum over the next few years as the use of a core/satellite approach within portfolios increases. Nguyen contends that “the use of lower cost strategies has allowed investors to gain exposure to high conviction funds without increasing the overall fee budget of their portfolio.”
Australian equities twist: High conviction funds deliver lower downside risk than core funds…
Zenith’s Report also suggests investors using high conviction strategies in their Australian equities portfolio are likely to have performed better in down markets compared to investors relying on traditional ‘core’ approaches.
In its Report, Zenith compared the performance and downside protection of core and high conviction strategies in its rated universe of Australian equity funds over the ten years to March 2018. Over this period, the average high conviction fund outperformed the average core fund by 0.78% p.a. after fees. Investors typically pay a higher annual fee for investing in a high conviction fund, averaging 1.18% compared to 0.89% for core funds.
Contrary to what may be expected, when measured by ‘downside capture’, high conviction funds fared better than their core counterparts. Over the ten years to March 2018, when equity markets declined 1%, high conviction funds fell by 0.91% on average, compared to core funds which declined by an average of 0.94%.
…and more diversification than the S&P/ASX 300 Index
In a further counter-intuitive twist, high conviction strategies provided greater sector diversification than the benchmark S&P/ASX 300 Index – which has a much higher number of stocks.
Zenith compared sector diversification using a ‘diversity index’, which quantifies how equally weighted a fund strategy is between eleven different equity sectors. High conviction funds had an equivalent of 6.5 equal-weighted sectors, compared to the S&P/ASX 300 Index with a score of 5.5. The Index’s low diversity score is largely due to the high concentration in the financials and materials sectors.
Zenith notes that it is not surprising that high conviction funds, which are generally constructed with limited consideration for benchmark weights, offer greater levels of sector diversification. Nguyen concludes that “investors need to be aware that holding a higher number of positions may not necessarily result in an increased level of diversification.”