Active managers need new measurement
Tuesday, 9 February 2016 1:01pm

The way active fund managers' returns are measured may not accurately reflect their value, negating up to 85 basis points in overall performance.

New research from the Centre for International Finance and Regulation (CIFR) finds the way performance is measured from disclosed holdings "contains systematic biases related to interim trading and the realisation of taxes."

The research by CIFR chief executive David Gallagher, Zhe Chen and Geoff Warren, indicates trading data is not taken into account in a meaningful way when fund performance is extrapolated from portfolio holdings.

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

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. CIFR said performance after tax is particularly relevant as it reflects the value that active fund management provides to investors.

"Our analysis showed that trading made a significant contribution - between 40 and 85 bps - to fund managers' performance. Indeed the bulk of observable alpha can be attributed to interim trading," Chen said.

"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."

Chen said the research has strong practical implications for fund managers and investors.

"Measuring fund performance in this way provides the appropriate tools to assess the value of active management - and active management fees," 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."

The study found growth funds generated higher capital gains relative to the benchmark via short-term trading, offsetting their lower dividend yields. By contrast, value funds needed to manage the timing of trades carefully in order to avoid losses versus the benchmark, despite earning excess dividend yields.

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