This is a result of the strong competitive forces at play within the Australian equity sector and the tough environment for retail flows. Increasingly, managers need to stand out from the pack. These are some of the key findings from S&P’s Australia-equity large-cap sector report, published today. 

This report covers 104 capabilities offered by 57 managers. Six managers received our highest five-star rating across a broad range of styles. While we affirmed the majority of ratings, we also upgraded eight funds (across five underlying managers) and downgraded nine (eight managers). Four funds remain ‘On Hold’. 

“While most large-cap Australian equity managers trumpet their ability to deliver consistent excess returns, the reality is that certain market conditions are more conducive to alpha generation than others,” said S&P Fund Services analyst James Gunn.

“The volatile market conditions we are currently experiencing are generally very favourable to active management, with compressed valuations creating opportunities for managers to purchase quality stocks at attractive valuation levels.” 

Key findings of the report include 

• Most Australian equity managers continue to espouse a bottom-up approach but there’s a much greater acceptance of macro issues as key swing factors and the value of informed top-down analysis.
• The rapid growth of the boutique business model over the past five years and the response by mainstream managers to shore up their key stock pickers has generally improved retention. High-profile departures and leadership changes will continue to occur, as we’ve seen again this year.
• An assumption of improved average tenure in future only heightens the importance of maintaining the right performance culture. It also raises the question as to whether the underlying drivers of turnover are likely to become more significant, given the “lock-in” of key individuals.
• A number of corporate transactions have taken place over the past year, while speculation surrounds a number of other managers.
• The past 18 months (2010 in particular) proved a more challenging period for the median large-cap Australian equity manager, as far as alpha generation.
• Given the narrowness of the Australian market, we’re increasingly of the view that managers should be prepared to take a broader approach to stock selection within the context of an S&P/ASX 300 investable universe, in an effort to enhance the consistency of excess returns.
• New large-cap products coming to market tend to be higher tracking error strategies clearly differentiated in their objectives. This is a trend evident in global equities for some time, and is a natural evolution within the relatively crowded Australian equity space.  

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We upgraded the Schroders Wholesale Australian Equity Fund to five stars and downgraded the BlackRock Wholesale Australian Share Fund to two stars. At the same time, we affirmed our ratings on 13 funds, including our five-star rating on the BT Wholesale Core Australian Share Fund.

“We upgraded the Schroders Wholesale Australian Equity Fund to five stars based on our overall conviction in the team and the durability of the investment process. Schroders has one of the largest teams in the market and we have a high regard for the quality and depth of its research. We consider the manager’s strong leadership structure and risk-awareness to be key attributes of this offering,” said S&P Fund Services analyst James Gunn.

The BlackRock Wholesale Australian Share Fund has struggled to meet its objectives since it was transformed to an insights-based approach in October 2008. The downgrade at this review cycle has been driven by our reduced conviction in the manager’s ability to identify value-adding investment insights, as well as implementation issues at the construction stage. 

Mr Gunn added: “In general, style-neutral funds are constructed with the objective of delivering relatively consistent outperformance through the cycle, irrespective of which investment style may be prevailing. However, these strategies will exhibit style tilts at times, as a function of both market opportunities and process, which can be an additional source of performance divergence. The funds in this peer group have generally been successful in generating excess returns over both the medium and long term.”

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