Hedge Clippings enjoyed catching up on Sky Business this morning with an old colleague, and frequently quoted market commentator, Macquarie Wealth Management's Martin Lakos, along with Ric Spooner from CMC Markets. Discussing actively managed funds with a couple of market professionals who come from a different section of the market provides one with a different perspective, which is always useful. Amongst other things we discussed the underperformance of the Australian equity market over the past 12 months (actually over the past 10 years) compared with other markets, particularly the S&P500, and how Australian managed funds have fared in this environment.

Inevitably these types conversations tend to quote averages, which remembering the old adage that if "one's head is in the freezer, and toes in the oven, than your average temperature is comfortable", means averages can be misleading. However we did quote both the average return of actively managed equity funds in 2017 (+13.10%) against the return of the ASX 200 accumulation index at +11.8% which suggested they performed marginally, but not dramatically better. However as per the freezer and oven analogy above, there's a dramatic range amongst the diverse nature of Australian actively managed funds.

For instance, taking all funds and all strategies, the best performing fund returned 75%, whilst the worst fell 21%. The median return was 13.34%, with 55% of all funds outperforming the ASX200, and with 95% of all funds in positive territory. With this extreme distribution spread of returns, inevitably questions were asked: Whilst there was certainly a focus on funds investing in small and micro cap stocks, plus those with Asian or global mandates amongst the top performers, this was by no means universal.

Equally it is difficult for a manager to consistently perform in the top quintile year in, year out, but undoubtedly the best ones manage to do so, if not every year, then at least regularly. Another aspect discussed was that top performance does not necessarily equate to the best returns: Frequently what investors are looking for, particularly in the absolute return space, is effective risk management thereby resulting in limited drawdowns.

Further discussions ensued regarding fund flows - whether positive or negative. We were happy to report that fund flows were broadly positive, albeit they obviously favour the better performing funds. However when looking behind the reasons for increased fund flows, anecdotal evidence would suggest that self-managed superannuation funds, or at least their trustees, are significantly made up of baby boomers, who as a natural result of their age, or financial security, are now more risk aware and less focused on trading individual stocks on the market than they were 10 or 20 years ago. At the same time they tend to have significantly more capital to invest, either on a personal basis or within their SMSF.

The other great benefit of a properly selected portfolio of managed funds, apart from hiring the expertise required, is the diversification obtained as a result. With most actively managed funds holding between say 25 to 75 individual stocks, with careful selection of even just five funds, an individual investor can have exposure to 100 to 300 stocks across multiple sectors and geographical markets, providing excellent diversification of risk. Certainly there is not the individual involvement of market trading that many investors enjoy, but sometimes leaving it to the experts is a safer and more relaxing option.

BENNELONG TWENTY20 AUSTRALIAN EQUITIES FUND

Attached is our most recently updated Fund Review on the Bennelong Twenty20 Australian Equities Fund.

• The Bennelong Twenty20 Australian Equities Fund invests in ASX listed stocks, combining an indexed position in the Top 20 stocks with an actively managed portfolio of stocks outside the Top 20. Construction of the ex-top 20 portfolio is fundamental, bottom-up, core investment style, biased to quality stocks, with a structured risk management approach.

• Mark East, the Fund's Chief Investment Officer, and Keith Kwang, Director of Quantitative Research have over 50 years combined market experience. Bennelong Funds Management (BFM) provides the investment manager, Bennelong Australian Equity Partners (BAEP) with infrastructure, operational, compliance and distribution services.

For further details on the Fund, please do not hesitate to contact us.

Australian Fund Monitors

ATTACHED FILESAFM Fund Review - December 2017 (pdf format)

ARCO ABSOLUTE TRUST (formerly Optimal Australia Absolute Trust)

AFM have released the most recently updated Fund Review on the ARCO Absolute Trust.

We would like to highlight the following aspects of the Fund;

• ARCO Investment Management is a specialist Australian equity investment manager and the Fund has a long/short equity strategy typically with a low but variable net market exposure comprising 40 to 65 stocks broadly selected from within the ASX200. 

• The investment team comprising George Colman, Peter Whiting, and Stephen Nicholls bring 100 years combined experience in equity markets.

• The Fund has an annualised return since inception of +8.53%. The Fund's approach to risk is shown by the Sharpe ratio of 1.39 (Index 0.30), Sortino ratio of 3.01 (Index 0.33), both of which are well above the ASX 200 Accumulation Index and has recorded over 79% positive months.

For further details on the Fund, please do not hesitate to contact us.

Australian Fund Monitors

ATTACHED FILESAFM Fund Review - December 2017 (pdf format)

BENNELONG LONG SHORT EQUITY FUND

Attached is our most recently updated Fund Review on the Bennelong Long Short Equity Fund.

• The Fund is a research driven, market and sector neutral, "pairs" trading strategy investing primarily in large large-caps from the ASX/S&P100 Index, with over fourteen-year track record and annualised returns of 16.38% p.a.

• The consistent returns across the investment history indicate the Fund's ability to provide positive returns in volatile and negative markets and significantly outperform the broader market. The Fund's Sharpe Ratio and Sortino Ratio are 0.99 and 1.64 respectively.

For further details on the Fund, please do not hesitate to contact us.

Australian Fund Monitors

ATTACHED FILESAFM Fund Review - December 2017 (pdf format)

With a new year beginning it is no doubt time to consider what's in store? Whilst tempting to think there's more of the same, things rarely work that way, but before we start looking into the crystal ball, let's take a look at the year that was:

From an Australian equity market perspective it started and finished well, but sagged in the middle before finishing up 11.8% on a total return basis. That's a reasonable return vs. cash, but it was the exceptionally low interest rate environment which helped explain a significant proportion of the equity market's performance.

Overall (allowing that some funds are yet to report their December results) the average return of all funds in AFM's data base broadly matched the market at +11%, while local equity based funds fared better at +13.97%. 

From a strategy perspective Long Only funds provided the best returns at +17.46%, followed by Long/Short and Equity 130/30 at +15.04 and 13.84% respectively.

Australian small caps with the big winners in 2017, particularly as the big banks and Telstra struggled. As a result those funds returning over 20% per annum tended to be focused on the small cap sector, or had a global or Asian geographic mandate.

On a global basis the Australian market significantly underperformed the S&P500's total return of almost 22%. One big difference between the two markets was that on average the ASX200 provided investors with a dividend return of 4.75%, compared with the S&P500 of 2.4%.

Looking forward: Undoubtedly on a global basis after 10 years of falling interest rates and central-bank support, equity markets have been, if not propped up, at least well supported. This environment however is coming to an end with interest rates in the US starting to rise in a (hopefully) measured fashion, whilst locally interest rate rises would seem to still be a few quarters away at least.

There's been much discussion in the media over the past couple of weeks with forecasts of more of the same for 2018, or alternatively the end of the dance party as interest rates increase. While there is certainly potential for that, provided the slow unsteady measured approach continues we would expect that equity markets, even though their valuations are stretched on a historical basis, will remain supported. However that won't go on forever, and at some stage there will be a switch in asset allocation. As ever, keep a watchful eye on the bond market, many times larger and more powerful than its attention seeking equity market cousin.

So if interest rates remain stable, or at least rise gradually, where do the risks lie looking forward? We would expect them to be political, both in Australia and overseas. Whilst Trump has reduced corporate tax rates to 21% in the US, he remains somewhat of a loose cannon - or should that be finger - either tweeting, or on the button. In the short term North Korea seems to have stepped back from the brink, but how long that may last is anyone's guess. In Europe Germany is not as stable as it was, and the whole Brexit fiasco is a distraction and has a long way yet to play out on both sides of the English Channel.

Closer to home, aside from political issues, it would seem that property prices will remain both a talking point and a significant risk, with household debt at record levels leaving the RBA with the challenge of a fine balancing act as and when the inevitable tightening cycle commences.