Quan Nguyen

Environmental and social issues have never been more important. The world’s eyes were firmly on Glasgow and the environmental issues discussed in the recently held 2021 United Nations Climate Change Conference (COP26).

As US President Joe Biden said during the conference: “There’s no more time to hang back or sit on the fence or argue amongst ourselves. This is a challenge of our collective lifetimes. [This is an] existential threat, [a] threat to human existence as we know it, and every day we delay, the cost of inaction increases.”

The investment world has long recognised these issues, with socially responsible investing (SRI) and environmental, social and governance (ESG) having been the hottest topics in the industry for a number of years.

How have investment managers responded to this interest?

To accommodate the increased interest, investment managers grew their offerings to include SRI variants and dedicated SRI managers have entered the market. The chart below highlights the increase in number of SRI-themed equity ETFs offered globally. ^[1]

The trend is rapid, with the number of offerings having increased almost nine-fold since 2014.

The number of funds managed with an SRI investment approach grew steadily until 2019, before accelerating over the most recent two-year period.

Whilst there’s been significant growth in this segment, the underlying strategies are diverse in their interpretation of SRI.

Different shades of green

If you ask 10 people what they expect in an ESG-focused fund, you’ll likely get 10 different answers. As such, we believe it’s important to understand the distinctions in approaches and history behind them.

The schematic below illustrates the evolution of ESG approaches over time.

Early examples of negative screens date back to the 1700s, when Methodist evangelicals avoided investment in a number of industries that they deemed harmful for themselves or their neighbours.

Unsatisfied with negative screens, investment strategies moved towards positive screens. The Domini 400 Social Index, which was launched in 1990, is an early example of an investment strategy that employs positive screens, only selecting companies with strong ESG principles.

Whilst elements of ESG integration are likely to have been considered since the dawn of investing, particularly regarding governance, ESG integration became increasingly common throughout the mid-2000s as the availability of ESG data increased. In 2010, the BP Deepwater Horizon Oil Spill highlighted the material impact that ESG risks can have on company valuations, with BP’s share price approximately halving in the three months after the disaster.

Following the establishment of the United Nations-supported Principles for Responsible Investment in 2005, managers have increasingly engaged with company management. Although this is typically performed to better understand company-specific ESG matters, if a manager believes a company’s approach to a certain ESG matter is inadequate, the manager may engage with the company and seek to positively influence its ESG approach.

Interest in thematic investing has accelerated in recent years, as investors seek exposure to trends and technologies that immediately address environmental or social issues, including health care, climate change and water solutions.

Whilst impact investing predominantly remains a strategy employed in private equity and debt markets, impact investing in public equities has seen strong growth in recent years. Managers offer portfolios comprising companies with technologies that address environmental and social issues, whilst providing additionality by providing primary market capital or targeted engagements.

Has money followed the hype?

Although there’s been growing interest in the SRI market segment for a number of years, investment flows were initially slow.

From a broader industry perspective, we’ve observed a steady increase in asset flows in SRI global equities strategies. The chart below shows the total funds invested globally into SRI-themed equity ETFs^[2].

As at October 2021, funds under management (FUM) attributable to SRI-themed equity ETFs was approximately $US 350 billion, representing a staggering increase of 2,200% from December 2014.

Can you have your cake and eat it too?

Its been a commonly held view that SRI strategies are ‘feel good’ investments that underperform traditional investments. Is this actually true? We analysed the average performance of five popular and longstanding SRI-themed global equities indices^[3] and compared them to the MSCI World Index over the past 10 years.

We found that the opposite is true, with the SRI-themed indices drastically outperforming the benchmark over the past 10 years, with outperformance attributable to the last two years.

It’s important to note that the indices performed broadly in line with the benchmark before the material performance divergence, which dispels the common notion that these strategies generally underperform.

So, it looks like SRI-focused investors might be able to have their cake and eat it too!

What’s your vice?

While it’s apparent that stocks which contribute positively to the environment and society are rewarded, how are traditional ‘sin’ stocks currently performing?

We identified the Advisor Shares VICE exchange traded fund, which predominantly invests in industries such as tobacco, gaming and alcohol. The chart below shows the performance of the VICE ETF against the MSCI World Index since its inception.

As the chart shows, investors are literally being punished for their sins in recent times. The stark performance differential between the SRI-themed indices and the VICE ETF highlights the shift in capital allocation towards ‘good’ companies by investment managers, on behalf of the underlying investors.

SRI and active management

With the outperformance of sustainable indices and the underperformance of the VICE Index, it’s apparent that active management can be a source of excess returns and risk reduction.

To assess this, we conducted analysis to determine whether an active manager’s approach to ESG opportunities and risks has had a material impact on fund performance. We grouped Zenith’s rated Global Long Only – Unhedged products by RI classification^[4] to determine a representative five-year performance for each cohort.

Given the relatively small number of thematic and impact funds on our APL, we’ve amalgamated funds from both cohorts for a more meaningful assessment. The chart below contrasts the performance of each cohort over the past five years.

Two key observations can be obtained from this analysis.

1. Strategies that have little or no consideration of ESG issues underperformed all other classifications.
2. Thematic and impact funds generated similar levels of performance as their aware and integrated counterparts.

While returns are an important consideration, we believe understanding the inherent risks involved with a particular investment is equally important. The table below captures the maximum drawdowns of each cohort over the past five years.

From this data set, it’s apparent that investment managers taking an active approach to the assessment of ESG matters have offered a greater level of capital preservation.

The future of SRI – a blurring of lines

While the diluted agreement that the world leaders reached at the COP26 may have disappointed many, the rapid rate at which the investment management industry has adapted provides some hope.

Looking into the crystal ball and judging from the current trend, we believe ESG integration will become mainstream and be the bare minimum expected for all investment strategies. Our view is shared by Larry Fink, the CEO of BlackRock, the largest fund manager in the world: “We are going to see evidence over the long term that sustainable investing is going to be at least equivalent to core investments. I believe personally it will be higher.”

By Quan Nguyen, Head of Equities Research

———-

[1] As recognised by Bloomberg Intelligence
[2] Ibid.
[3] FTSE Environmental Opportunities All-Share Index, S&P Global Clean Energy Index, MSCI Global Environment Index, FTSE4GOOD Developed Index and MSCI KLD 400 Social Index.
[4] For more information on the criteria of each RI classification, please see section 2.3.2.

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Quan Nguyen

In January 2021, prominent hedge funds were making international headlines for all the wrong reasons. Terms such as ‘shorting’, ‘GameStop’ and ‘short squeeze’ were being thrown around in daily conversation, driven by a Reddit-fuelled rampage that caused unprecedented volatility in global financial markets. Given the myriad of negative publicity surrounding shorting that stemmed from the GameStop situation, many investors could be forgiven for thinking that shorting is a fool’s errand.

However, we believe that shorting is highly beneficial when used effectively. In fact, given the ability to express negative views unencumbered through short selling, a long/short manager has a significant advantage over a long-only manager, which is restricted by its mandate from expressing meaningful negative stock views.

Is the ability to express negative views an issue for Australian managers?

Over the past 20 years, the number of stocks that have a weight of less than 0.5% in the S&P/ASX 200 Index has been trending up, with the chart below illustrating this point.

From a low of 137 stocks in 2001, the number of stocks with a weighting of less than 0.5% has increased to 156 (as at 31 May 2021). What’s notable from the chart is the trend over the past three years, with stocks such as CSL and Afterpay partially responsible for the strong upward trend. These stocks have experienced extraordinary share price gains, which has resulted in an increasingly top-heavy index. Further illustrating this point is the chart below, which compares the average weight of each stock in the S&P/ASX 20, S&P/ASX 21-50, and the S&P/ASX 51-200.

It’s evident that the largest stocks overwhelm the smallest in the index, with this trend accelerating in recent years.

A typical long-only manager that seeks to take an active position (positive or negative) may easily do so on the largest stocks within the S&P/ASX 200 Index, where the stock weights range between 3% and 8%. However, as we go down the market capitalisation spectrum, it becomes increasingly difficult for long-only managers to take active underweight positions.

Let’s suppose a long-only manager dislikes a certain stock in the index that has a benchmark weight of 0.5%. To express this negative view in its strongest form, the manager would only be able to have no exposure to the stock, which is a 0.5% underweight; a relatively low conviction active position.

However, a long/short manager is unrestricted by the zero bound of index weights and may short sell to express a larger underweight position. For a skilled active manager, the more investment options available, the greater the probability of delivering strong investment outcomes.

Is Australia a good place to short?

In January 2021, prominent hedge funds were making international headlines and, perhaps for the first time ever, “shorting” was a word being exchanged in daily conversation, even by those unfamiliar with financial markets. For those investors with doubts around the efficacy of shorting after the GameStop situation, evidence from the Australian market paints an optimistic picture.

To understand the performance of short selling in Australia, we ranked the constituents of the S&P/ASX 200 Index based on the level of the share register that’s short sold. To capture the results concisely, we’ve grouped the constituents according to quintiles, rebalanced monthly.

The difference between the performance of the top quintile (most shorted stocks) and the bottom quintile (least shorted stocks) is shown below.

Although short selling both quintiles would have generated negative absolute returns, as the market has gone up over this period, shorting the top quintile would’ve been significantly less painful than shorting the bottom quintile. The difference between the two quintiles was 2.1% p.a. over this period. As such, short selling the most shorted stocks has been highly beneficial from an excess return perspective.

Investors could be forgiven for looking at this chart and believing that shorting is simple; find the most shorted stocks in the S&P/ASX 200 Index, short them, and realise strong relative gains. Although the evidence suggests that this strategy would work, we believe it’s important for investors to understand that it comes with extreme bouts of volatility.

A skilled long/short manager is crucial in navigating the market for relevant short ideas, with appropriate stock selection and portfolio management materially reducing the risks involved.

Although shorting can, and often does, result in more volatile outcomes, we believe it can be controlled and used by a skilled long/short manager to achieve strong investment outcomes. Long/short managers can achieve stronger risk-adjusted returns than long-only managers, with the short-selling capability unlocking their potential.

By Quan Nguyen, Head of Equities

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Quan Nguyen

The European Commission’s second Markets in Financial Instruments Directive (MiFID II) came into effect on 3 January 2018, aimed at increasing competition and fee transparency amongst market participants inside and outside the European Union.

In its International Shares sector report, Zenith Investment Partners found that sell-side analysts were migrating to the buy-side as a direct result of MiFID II, leading to larger and more experienced investment teams.

Following on from this, Quan Nguyen, Head of Equities, sought to quantify the characteristics of investment teams that led to the most optimal outcomes. This analysis was conducted on a variety of global equities fund managers based on their performance over the five years to September 2019.

Zenith’s study suggests that large teams driven by a compact decision-making approach tend to exhibit greater levels of outperformance compared to alternative structures.

While Zenith uncovered the characteristics of the “optimal” investment team, it does not believe that there is a single template that managers should follow to succeed.

“We have reviewed successful managers that do not align with the optimal characteristics and unsuccessful ones that mirror the ideal template,” said Nguyen.

“Overall, we believe a team’s ideal structure needs to align with its investment philosophy and process.”

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Quan Nguyen

Duration, despite being a common measure within the fixed income community, is a relatively foreign concept when it comes to equities. However, the latest research from Zenith Investment Partners shows that considering equity duration can be a powerful tool in constructing investment portfolios.

Duration is the length of time required for cashflows from an asset to fully repay the initial investment, explains Quan Nguyen, Head of Equities at Zenith.

“In the case of equities, we measure duration through dividend yields. For example, if a stock has a dividend yield of 5% p.a. it would take 20 years for its dividends to fully repay an investor’s capital. This represents a duration of 20 years.”

Long duration equities are expected to deliver a higher proportion of future cashflows in the distant future, while short duration equities are expected to deliver a higher proportion of cashflows in the near future. The other important characteristic to note is that long duration equities are more sensitive to interest rate movements and as a result have benefited more from the recent decline in Australian interest rates.

“At Zenith, we believe it is important to assess portfolios holistically. This means considering equity duration alongside fixed income duration,” said Nguyen.

To help advisers better understand equity duration, Zenith, in its 2019 Australian Shares – Large Companies Sector Report, looks at the duration of stocks within the Australian equity market.

“Our research found that for the 5 years to 31 March 2019, growth styled funds exhibited longer duration than value styled funds and have therefore benefited more from falling interest rates,” explains Nguyen.

“If we split the universe into large caps and small caps, it yields a similar interpretation. Large caps are typically shorter duration relative to small caps.”

Understanding equity duration means that investors do not need to be overly concerned if their fixed income duration is underweight, as this can be offset by a tilt to small caps or a growth fund within the equities component of their multi-asset portfolio.

Ultimately, Nguyen believes that the consideration of equity duration will help investors achieve a more balanced investment outcome.

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Quan Nguyen

From time to time, the market reminds us of the inherent volatility of equities as an asset class. The December quarter of 2018 was a clear example of this, with the S&P/ASX 300 Index falling 8.4%; its largest quarterly decline since September 2011. However, the quarter was even tougher for smaller capitalisation stocks, with the S&P/ASX Small Ordinaries Index falling 13.7%. Zenith believes this comes as no surprise given historically, small companies have displayed higher beta (market sensitivity) relative to their larger counterparts.

Quan Nguyen, Zenith’s Head of Equities, noted that “The higher market sensitivity of smaller companies is generally underpinned by three main factors: higher concentration of unprofitable companies; lower liquidity; and a lack of research coverage.”

However, Zenith highlighted that an exposure to smaller companies can be gained without higher levels of market sensitivity when active management is employed. “Over the longer term, our rated active smaller companies funds exhibited market sensitivity levels that were either lower or similar to the broader market”.

Zenith noted that its rated Small Cap managers were able to generate an average excess return over the Index of 2.5% over the 12-month period ending 31 December 2018. One of the key aspects highlighted by Zenith’s research was the benefits of drawdown protection and the impact it can have on the subsequent recovery on an investor’s capital balance.

To illustrate this, an individual who invested $100 in a passive smaller companies index at its peak in October 2007, would see their investment fall to $90 as at 31 December 2018. In contrast, an individual who invested $100 in the average actively managed smaller companies fund rated by Zenith would have seen their investment grow to $179.

In addition, Zenith noted that during the Global Financial Crisis, its rated smaller companies universe of funds recovered from drawdowns significantly faster than the broader small cap market, with the average recovery duration being 25 months. The smaller companies index came close to breaking even in August 2018, however it remained underwater as at 31 December 2018.

Nguyen noted, “In general, smaller companies managers have participated fully in market upswings whilst also providing significant downside protection. We believe this highlights the benefits of active management, especially in less efficient segments of the market”.

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However, alternatives in the form of Australian market neutral funds largely turned in a relatively disappointing performance over 2018, with Zenith’s rated funds returning an average of -3.2% (after fees), which was roughly in line with broader Australian equities.

Despite this, Quan Nguyen, Zenith’s Head of Equities, believes equity market neutral strategies offer investors a return stream that is not correlated to traditional asset classes over the longer term, which acts as an important portfolio diversifier.

Nguyen said, “It is important to remember that market neutral funds are expected to have no correlation to equities over the longer term, not negative correlation. As such, there may be short periods where market neutral strategies exhibit similar directional movements as equities”.

“However, in these relatively isolated instances where both experience negative returns, we expect market neutral strategies to protect capital, as was the case in late 2018”.

Zenith noted that over the December quarter drawdown, the average Australian equity market neutral fund outperformed the broader Australian equity market by 3% (after fees).

“Long-term equity market data shows that Australian equities have had one negative year approximately every four years since 1984. While the recent strength of equities markets may have potentially given rise to complacent investing, 2018 was a reminder that alternative sources of returns are required to ensure balance within an investor’s portfolio. Equity market neutral strategies offers investors a return stream that is not correlated to traditional asset classes over the longer term”.

The drivers of negative returns

Nguyen stated that there were two main drivers of performance for Australian market neutral funds over the 12-months ending 31 December 2018.

“Whilst volatility returned to equity markets, low levels of dispersion across individual stocks resulted in an unproductive environment for active managers.”

“In addition, the typical long bias that Australian market neutral funds maintain towards smaller companies created a strong headwind during the year. Smaller companies underperformed their larger counterparts by 5.6% over the year.”

Zenith noted that Australian market neutral funds typically maintained a net-long bias towards smaller companies, given the challenges of enacting short positions in this segment of the market.

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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.”

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Quan Nguyen

In the past month Zenith has been the first Australian research house to rate three new funds from Airlie Funds Management and Firetrail Investments, and as Zenith’s Head of Equities Quan Nguyen explains, backing selective funds early is all part of a value proposition that can benefit adviser clients and their investors.

That’s because like companies, investment funds often have their own life cycle and the potential for strong performance can change as a fund grows and new investors get on board. In the equities space this is particularly true: as the best opportunities are ultimately finite, and getting into a fund early when trading is most agile, can often mean a big difference in returns for investors. In theory at least, the larger a fund grows, the harder it is to sustain the performance of its early days. Wait several years and you have a real prospect of missing the investment boat.

In February this year, Zenith published a research report that determined the best time to invest in a smaller companies fund is at the beginning of its life. Zenith believes this is due to lower levels of FUM during the early stages of a fund’s life. This allows the fund manager to be more nimble when trading stocks, in addition to having a broader investment opportunity set relative to peers who manage more assets. Zenith found that the average Small Cap fund outperformed its benchmark by approximately 12% in the first 12 months of its life. However, as the funds matured, the average excess return gradually declined to a more subdued, albeit still attractive, 7.9% p.a. by year 10, before gradually converging towards approximately 7% p.a. thereafter. As such, we believe value still remains in investing in funds that are more mature with established track records.

Zenith’s philosophy is to empower its advisers to deliver best of breed financial advice by accessing the world’s best investment opportunities as soon as practicable. That requires having a broad, lateral and empathetic mindset on what advisers and their clients require as investment solutions, often before they may be aware of its availability. It requires flexibility from a research team in what is an extraordinarily busy annual review cycle covering over 780 funds. It also requires a bold commitment to review funds through an established and thorough process – no shortcuts. Even if the opportunity for investors appears very compelling, a research rating requires a deep dive and factual assessment of whether a fund can deliver on its objectives for investors.

Quan said “In rating funds early, we need to balance out the priorities and probabilities of approving investment solutions that will add the most value to our advice clients, while allowing an appropriate track record to develop to ensure all ratings are based on solid fundamental principles and high conviction”.

Mark Burgess, Head of Research Relationships at Magellan said “Zenith has shown a willingness to identify and rate quality strategies early. They were first to rate the Magellan Global Fund in September 2007 and they have backed this up again by being first to rate Airlie in June 2018.”

Airlie Funds Managment rated first by Zenith

On 1 June 2018, Zenith initiated coverage on the Airlie Australian Share Fund with a Recommended rating.

The Fund is managed by Airlie Funds Management (Airlie) and distributed by Magellan Asset Management (Magellan). The Fund provides investors with a fundamentally driven, quality and value styled, Australian equities exposure.

Zenith has known both portfolio managers John Sevior and Matt Williams during their tenures at Perpetual where the strategies they managed generated attractive absolute and excess returns.

Zenith has a high regard for Airlie’s senior investment personnel and believes the investment process employed has the Fund well positioned to achieve its investment objectives.

Firetrail Investments rated first by Zenith

On 8 May 2018, Zenith initiated coverage on the Firetrail Australian High Conviction Fund and the Firetrail Absolute Return Fund. The Firetrail Australian High Conviction Fund has been rated Highly Recommended whilst the Firetrail Absolute Return Fund has been rated Recommended.

Zenith’s conviction in the Firetrail Australian High Conviction Fund is underpinned by the consistent application of the investment process which produced impressive long-term excess returns during the investment team’s tenure at Macquarie Asset Management (MAM). Despite the recent formation of the business, Zenith has a high regard for Firetrail’s investment personnel and capabilities and believes the Fund is well placed to meet its investment objectives.

More funds on the pipeline

Zenith is committed to uncovering new, quality investment strategies and presenting new options to its advice practice clients. With each sector asset class review, consideration is given to new funds that may be included in the ratings universe. In the most recent Australian Fixed Income Sector Review released on 31 May 2018, Zenith introduced five new fixed income strategies to the ratings universe.

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Since 2016, the number of Micro Cap funds in Zenith’s rated universe has increased 125%, while the total funds under management (FUM) in Zenith’s rated Micro Cap funds increased from $115 million to $702 million over the three years to 31 December 2017.

Over the same period, Micro Cap funds rated by Zenith delivered a median return of 26.3% p.a., significantly outperforming the S&P/ASX Emerging Companies Index by approximately 9.4% p.a., with materially lower risk.

The median Small Cap manager on Zenith’s Approved Product List (APL) underperformed the S&P/ASX Small Ordinaries Accumulation Index by 4.3% (net of fees) over the 12-month period ending 31 December 2017. Over the same period, the median Mid Cap manager on Zenith’s APL achieved performance (net of fees) which was broadly in line with the S&P/ASX MidCap50 Index, while the median Micro Cap manager outperformed the S&P/ASX Emerging Companies Index by approximately 2.2% (net of fees).

Micro Cap funds will typically invest in companies outside of the S&P/ASX 300. They are generally highly volatile due to the lack of publicly available research on stocks and impact of strong capital movements. That said, they offer a high performance potential due to these risks.

Zenith Head of Equities Research Quan Nguyen said “stocks at the small/micro end of the market capitalisation spectrum have wider performance outcomes, which reinforces Zenith’s view that Micro Cap investing requires professional investment managers who possess the necessary experience and expertise to avoid the inherent risks.

The strong performance of the Micro Cap segment and limited capacity available have led to a number of Micro Cap offerings reaching capacity and closing to new investment. However, with the recent arrival of a number of new funds, the available capacity across the Micro Cap segment (currently rated by Zenith) has increased significantly.

The Micro Cap fund universe came within $200 million of its collective capacity in June 2016, however the rise in number of Micro Cap funds has translated to approximately $1.2 billion of total capacity becoming available as at 31 December 2017. However, extrapolating the FUM growth for the 2017 calendar year of approximately $400 million, we estimate that this capacity would be filled within three years.

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Commenting on the review, Quan Nguyen, Senior Investment Analyst and Zenith’s lead analyst on the Australian Shares – Large Companies sector said, “On average, funds on Zenith’s Approved Product List returned 1.5%, net of fees for the 12 months ending 31 May 2016, which represented an outperformance of 3.6% relative to the S&P/ASX 300 Accumulation Index.”

In summarising the findings of the review, Nguyen highlighted “The key driver of outperformance for Zenith’s rated active funds has been stock selection. In particular, the stock selection driven decline in exposure to Blue Chip stocks (the S&P/ASX20 Index) has been a trend that has paid off.”

Commenting further, Nguyen said, “For the concentrated managers within the sector, the average exposure to the Top 20 stocks dropped by almost 10% from 2014 to 2016. Furthermore, the S&P/ASX 20 segment of the market materially underperformed the broader index over the last 12 months (ending 31 March 2016), with the ex-20 segment of the market returning 3.4% versus -16.2% for the S&P/ASX 20.”

“The Blue Chip/Top 20 index is dominated by Australian Bank stocks, and this has been one of the hardest hit segments of the market over the last 12 months.”

Nguyen also noted: “For some time, Australian Blue Chip stocks have been among the highest yielding segments of the market.  The reversal in relative performance of Blue Chips, has definitely made investors question whether the yield trade is over?”

Zenith believes that while the spread between the RBA cash rate and the market dividend yield remains relatively wide, high and stable dividend paying securities will remain attractive to income seeking investors. In other words, while interest rates remain at record lows, investors will continue to look to high and stable dividend paying stocks as an income source.

Nguyen concluded: “As part of the review, Zenith surveyed all managers on forward looking market prospects. In aggregate, the Australian equities managers Zenith reviewed identified the S&P/ASX 51 to 100, or Mid Cap, segment of the market as being the most attractive for the next 12 months.”

Summary of the Zenith 2016 Australian Shares – Large Companies Sector Review

From an initial universe of 186 products:

• 13 were rated “Highly Recommended”
• 55 were rated “Recommended”
• 21 were rated “Approved”
• 5 were placed on “Redeem”
• 92 were “Not Rated”

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