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Active managers being dudded on returns

Assessing the value of active management based solely on disclosed holdings may well be selling fund managers short, according to a new paper.


The Centre for International Finance and Regulation (CIFR) has released a new paper that suggests the way active manager's returns are measured may not accurately reflect their value.

The research, conducted by CIFR chief executive David Gallagher, Dr Zhe Chen and Dr Geoff Warren, found that the way performance is measured from disclosed portfolio holdings contains "systemic biases" related to interim trading and realisation of taxes.

"The trouble is that trading data is not taken into account into a meaningful way when fund performance is extrapolated from portfolio holdings," said Dr Chen.

"When performance is measured on holdings only, and this negates a significant portion – up to 85 basis points – of the value that is added by good active management," he added.

The study compared returns on simulated portfolios with simulated pre- and post-tax benchmarks based on the S&P/ASX 300 Index. The study was designed to show the contribution that interim trading and taxes make to total fund alpha.

"Our analysis showed that trading made a significant contribution – between 40 and 85 basis points – to fund managers’ performance – indeed the bulk of observable alpha can be attributed to interim trading," said Dr Chen.

"It also clarified that after-tax fund performance can only be accurately measured when trade data is taken into account. The timing and price of trades allows accurate evaluation of tax effects, which can be significant," he continued.

The research has "strong practical implications" for fund managers and investors – particularly when it comes to the assessment of fees, Dr Chen said.

"It takes away subjectivity from this long-running argument and provides the tools to accurately and precisely measure the contribution that good or bad trading makes to a portfolio. Over the long term, this should improve investment outcomes," he added.

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