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Decentralised portfolio management: analysis of Australian accumulation

funds

Hazel Bateman (UNSW)Susan Thorp (UTS)

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There is increasing investment choice in Australian superannuation

Investment choice offered by 78% industry funds, 76% retail funds, 60% public sector funds

Av. 7 choices (industry funds), 59 choices (retail), 6 (public sector)

85% assets are in super funds offering investment choice

(Source: APRA 2005)

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Choice menu

Not-for-profit super funds: multi-manager diversified portfolios (capital guaranteed, capital stable, balanced, growth etc….) trustee boards (and their advisors) then choose

specialised investment managers (mandates) on behalf of members - delegated choice of investment managers

401(k)s (US), Premium Pension (Sweden), Australian retail funds, offer members direct choice of specific investment managers Av. 10-12 for 401(k) plans and up to 5 from over

650 for the Swedish scheme, av. 59 for Australian retail funds

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Delegated funds management in superannuation

Member contributions into investment options

Cash Balanced GrowthCapital stable Asset classes

Trustees (+ asset consultants)

Investment mandates

Dom stocks Dom FI Property Int’l stocks Int’l FI Diversified Cash

Investment returns

Crediting rates

Cash Capital stable Balanced Growth Asset Classes

Taxes, costs, smoothing

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Mandate trends

1 to 59 mandates per super fund (av. 12)

Av. 22 mandates per manager

Large super funds more mandates than small super funds

Diversified mandates becoming less popular (15% in 2004, down from 50% in 1998)

(Source: Rainmaker 2004)

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Does this additional layer of management create value for retirement savers?

1. What is the impact of using more managers (mandates)?

2. Do these delegated investment funds do better than a group of standard asset indexes?

3. Are trustees (and their advisors) able to choose managers with more skill than an uninformed investor?

4. Are the benefits, if they exist, passed on to members’ accounts via realised crediting rates?

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Data

Construct a monthly series of portfolio returns for nearly 200 not-for-profit super funds

=

Mandate weights from Rainmaker 2004 survey of mandates for not-for-profit super funds (90% not-

for-profit sector, 1/3 superannuation assets)

+

3 years of gross monthly returns for each investment manager (Jan 02 – Dec 04)

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1. What is the impact of using more managers

(mandates)?

.

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Average annual investment return by individual fund Jan 2002-Dec 2004

0

2

4

6

8

10

12

14

59 37 33 27 22 21 18 16 15 13 12 10 10 8 6 5 4 2 1 1

number of managers

retu

rn, %

p.a

.

Mean return declines as mandate numbers decrease

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Annualised standard deviation of monthly return by individual fund

Jan 2002 - Dec 2004

0

2

4

6

8

10

59 36 31 26 22 20 18 15 13 12 10 10

7 6 5 2 1 1

number of managers

stan

dar

d d

evia

tio

n,

% p

.a.

Highest risk: funds with 6-12 mandatesLowest risk: funds with 13-22 mandates

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Return to risk ratio by individual fund

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.559 36 30 25 21 18 16 14 12 11 10

7 6 4 2 1 1

number of managers

aver

age

retu

rn/s

tan

dar

d

dev

iatio

n

Av. return/risk for >12 mandates is 1.3 (1.0 for < 13)

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Pooled data (4 groups) to allow additional analysis of fund vs fund

Tested for significant differences in realised volatilities between the 4 groups

Least risky returns for super funds with 13-21 mandates with no significant reduction in risk from adding more mandates

No significant reduction in risk when move from 1-5 to 6-12 mandates

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Pooled data (4 groups) to allow additional analysis of fund vs fund

Tested for stochastic dominance to investigate whether the differences between realised portfolio returns matter to a risk averse investor

Returns from larger mandate groups dominated returns from all other groups (and would be preferred by risk averse investor)

Except - no clear ordering over returns to 1-5 and 6-12 groups

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Overall – fund vs fund

Super funds with >12 managers (mandates) show significantly less volatility and overall higher returns than super funds using < 13 mandates

No significant advantages to members of super funds who choose 6-13 rather than less managers

Super funds with more mandates preferred by risk averse investors

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2. Do these delegated investment funds do better than

a group of standard asset indexes?

.

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Spanning tests to compare actual fund performance against a benchmark constructed from a set of asset class indexes

Excess returns on = (Excess returns on

benchmark index actual super fund

portfolio)

Test null < 0

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Results: super funds vs benchmark

Optimally diversified benchmark -> no super fund in sample spanned the benchmark

Equally weighted benchmark -> 25% super funds in sample spanned the benchmark

Probability of spanning increased with number of mandates -> 50% super funds in largest group

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3. Are trustees (and their advisors) able to choose managers with more skill than an uninformed

investor?

.

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Spanning tests to compare random selection of fund managers (vs benchmark) to actual selection by super funds (vs benchmark)

Unconstrained selection of fund managers random choice more likely to span benchmark

than actual funds in 1-5 and 6-12 mandate groups

Constrained selection – at least one manager per asset class Random choice more likely to span benchmark

than actual funds in all except 22-59 mandate group

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Results: simulated super funds vs benchmark

Delegated investment choice no better than an individual following a naive diversification strategy

Except where super funds used many mandates (22-59)

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4. Are the benefits, if they exist, passed on to members’

accounts via realized crediting rates?

.

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Crediting rates and investment returns by mandate group, June 2003 - June 2004

0

5

10

15

20

22 to 59 13 to 21 6 to 12 1 to 5

number of mandates

per

cen

t p.a

.

crediting rates investment returns

Funds with 22-59 mandates appear to generate higher investment returns, but similar crediting rates

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Conclusions

Funds with few mandates performed poorly Funds with many mandates add value on risk

adjusted basis and more likely to span an equally weighted benchmark

Uninformed individuals with naive diversification strategy perform better than many actual mandate selections

Unclear whether better investment performance of funds with many mandates translates into higher crediting rates

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Coming up next……

Repeat for choice menu of Australian retail funds

Use fund specific data to analyse characteristics of funds with superior performance

Further investigate gap between gross investment returns and crediting rates

Extend analysis to actual choices