Brent Sheather: NZ shares vs the rest of the world

Despite falling prospective returns many local fund managers continue to charge performance fees.

According to the History channel the D-Day Landings in June of 1944 owed their success, at least in part, to the allies' mis-information strategy.

Consequently the German's thought the allies would land at one place and, goodness me, they landed somewhere else.

Distorting the facts is a powerful tool if done properly particularly if the facts are a threat to your business model. Because it extracts high fees relative to returns the fund management industry has had to become one of the foremost experts in this field. Their mis-information strategies range from overstating prospective returns in each asset class to exaggerating the need for complexity and information in managing assets.

For example we have all seen the fund manager interviews where they profess to be genuinely concerned that we are not saving enough for our retirement but they don't say that a 1 per cent reduction in fees is the easiest and most obvious strategy for improving savings outcomes. It's great theatre but as investment advice not so good.

Up until recently it has been more difficult than it should be to see through the mis-information strategies of fund managers and their investment advisor puppets but thanks to the sterling efforts of Robert Arnott, John Bogle and Clifford Asness, amongst others, writing in the Financial Analysts Journal and other publications it is now crystal clear that historic equity and bond returns can't continue, unless of course markets were to fall sharply first.

Arnott and Peter Bernstein in a paper entitled "The Two Percent Dilution" went to the trouble to decompose historic returns so that we can get a more informed view of the future. Despite the theory and the fact that fund managers are highly trained many choose to ignore the facts. One local fund manager forecasts that the future return from global equities will be a function of GNP growth when the facts show clearly that in the long run there has been a 2 per cent dilution. No explanation as to why the future will be different from the past.

For many students of the long term history of financial markets the annual Global Investment Returns Yearbook is something of a highlight and it has certainly been a feature of this column for the last 10 years or so.

The 2016 Yearbook has been sitting on my desk for too long so this week we will, at the risk of boring regular readers, look at how the historic returns from New Zealand compare with the rest of the world. The good news is that over the period 1900 to 2015 NZ shares have returned an average of 10.0 per cent pa which compares pretty well with the 8.1 per cent pa for the world stockmarket in the same period. However we need to compare apples with apples and the 10.0 per cent is in NZ$ whereas the 8.1 per cent pa is in the US$.

Over the period the NZ$ has fallen by about 1.0 per cent pa against the US$. Whilst this doesn't sound like much it adds up to a depreciation of the NZ$ against the US$ of about 70 per cent over the period.

The average 10 per cent return on NZ shares over the 1900 - 2015 period translates to big numbers thanks to the power of compound interest - $1.00 invested in 1900 would be worth around $64,000 in today's dollars or $1027 adjusted for inflation.

As could be expected, for the hypothetical low risk investor who decided to invest his/her $1.00 in 1900 in short term bank deposits, the return wasn't nearly as good - $1.00 would have grown to $431 in nominal terms but once adjusted for inflation just $6.90. All these numbers assume no fees and no tax.

Whilst the lucky share investor with $1.00 invested in 1900 would have seen his dollar grow to over $1,000 in real terms, if they had paid the industry average of 3 per cent in management, monitoring, performance and trading fees then the real terminal sum would drop to just $37.40. Fees are highly important and a recent Morningstar article argues that they are just about the most important thing to look at when making an investment decision, after asset allocation.

Speaking of which one decision investors need to make is how much, as regards their share portfolio, to invest locally and overseas.

The average 10 per cent return on NZ shares over the 1900 - 2015 period translates to big numbers thanks to the power of compound interest - $1.00 invested in 1900 would be worth around $64,000 in today's dollars or $1027 adjusted for inflation.

The facts show clearly that NZ's performance over the very long term has been quite reasonable and this could be expected to continue given that NZ shares attach imputation credits to their dividends, effectively making them tax-free for many investors.

A few years' back some fund managers and financial advisers used to produce a graph showing what an efficient portfolio looks like - maximising returns whilst minimising risk.

At the time the graph showed that the best combination of international and local stocks was about 80 per cent international and 20 per cent local because in the ten years prior to that local stocks had underperformed with high levels of risk. They have stopped doing that because today, given historic performance, the best combination is to be highly overweight NZ stocks. This exercise was and still is a waste of time because the data is historic and bears little or no relevance to the future.

Despite falling prospective returns many local fund managers continue to charge performance fees.

A couple of weeks back in a stock exchange announcement the Kingfish directors sanctioned another $1 million plus performance fee payment. Kingfish shareholders could be forgiven for wondering why this happened.

According to our numbers in the 12 months ended 31 March KFL shares returned 4.3 per cent. In the same period the NZ stockmarket returned 16.5 per cent. I haven't got a CFA degree but that doesn't sound like "outperformance". In the 12 months we estimate that KFL's Net Asset Value per share rose by 10.5% which is better but it isn't 16.5 per cent is it.

For more perspective let's see how the people who weren't clever enough to buy active managers and just bought index funds did in the same period. My goodness the silly old computer that runs SmartFONZ did 14.1 per cent, the one in charge of SmartTENZ did 14.8 per cent and SmartMIDZ did 16.3 per cent and I don't think I have had an email from any of the computers asking for a bonus.

Over in the UK the independent directors of many investment trusts have got rid of performance fees. Just the other day the directors of the Baring Emerging Europe fund, in the interim report, said "This performance fee element seems to the Board to be increasingly outdated ... so we have agreed with Barings that the performance fee will be discontinued from the 31st March". Maybe the Kingfish directors are, like the Sex Pistols sang, "out at lunch".

Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have an interest in the companies discussed.