Hedge Clippings | 17 February 2023
This week Hedge Clippings thought we'd give inflation, interest rates, and RBA Governor bashing a rest. After all, it's been front page news for a couple of weeks (or should that be months) and culminated in Philip Lowe appearing before a Senate Committee grilling today for the second time this week. For the record, he's sticking to the script that inflation is the number one problem, that unemployment could reach 8.5% if it wasn't fixed, and the only way to fix it is to keep on raising rates even at the risk of recession. He acknowledged, as we suggested last week, that increased interest rates hurt the vulnerable most, and the impact "is being felt very unevenly across the community". Being in the sights of politicians asking some plainly uneducated questions (surprise, surprise), he did have a dig back, saying that he could make decisions that politicians couldn't, or wouldn't, with this comment: "It's hard for the political class to take the short-term decisions to manage the cycle."
Ouch! Moving right along...
If ever there was a year to reinforce the twin benefits of diversification, and taking a long-term view when investing in managed funds, 2022 would be it. Surprisingly, given the well publicised, painful, and costly examples of ignoring each, (or both) they're two of the standout lessons from an analysis of 2022 fund performances.
Against a backdrop where few anticipated the sudden outbreak of inflation, or the speed and extent of central banks' reaction, overall the market had a shocker. The 12 month returns of 16 Peer Groups to December 2022 shows that only Debt (+5.11%) and Hybrid Credit (+4.20%), and to a lesser degree Infrastructure (+0.94%) provided investors any comfort. Equity funds, particularly Small/Mid Cap, both in Australia and globally, bore the brunt at -19.34% and -23.31% respectively. On a relative basis, Australian Small/Mid Cap funds underperformed their overseas peers with the average fund (-19.34%) underperforming the broader ASX200 T/R index (-1.08%) by over 18%. By comparison, while Global Small/Mid Cap funds averaged a negative return of -23.31%, this was "only" 5% below the S&P500 total return of -18.11%.
While one can therefore argue that small caps weren't the place to be in 2022, taking a longer view - as recommended in every offer document for a managed fund we've ever seen - provides a more balanced view. In the three prior years, 2019-2021, Australian Small/Mid Cap funds returned 27%, 18%, and 21% p.a. respectively, and over the prior 10 years this group had only one negative year (-6.5% in 2018) and no less than six years of +20% returns. Taking it back even further to 1995, this Peer Group has returned an average of over 15% p.a. with an up capture ratio of 137% (in other words, 37% above the market's return when it is positive) and a down capture ratio of 95% (showing when the market falls, they fall almost as much).
For the record, not all small/mid cap managers suffered as badly, but consistency across the cycle is difficult. Over 3 and 5 years only two - Anacacia Wattle Fund (+16.79% and 16.73%) and Glenmore Australian Equities (+16.37% and 17.42%) beat the long-term (25 year) peer group average of 15% and outperformed the ASX200 in 2022.
And while some investors in Small/Mid Cap funds may be nursing losses in FY2022 (average -17.58%) that had reversed by FY January 2023 to +12.18% since July last year.
There lies Lesson #1: Investing in managed funds requires a long term view.
Lesson #2: Diversification, and distribution of funds' and indices' returns. Diversification is a two edged sword: Over diversification can flatten performance. Concentration - such as investing in a single fund or product - can lead to significant under-performance. While still on the small mid cap peer group - although this runs true across the board - the spread of performance is significant, particularly in market sell-offs. 2022 saw small/mid cap managers' performance range from +3.53% through to -43%. The dilemma, for investors and advisors alike, is how much to diversify, and how to avoid long-term underperformers, or worse still, the likes of Mayfair 101.
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