Research shows global shares funds struggle to justify their fees, reports John Collett.

A survey of the performance of 17 managed funds that invest in international shares shows dismal results, with many either failing to beat the sharemarket index or exceeding it by only a narrow margin.

Over the five years to December 31, 2003, the funds researcher Lonsec found that only eight funds beat the index by 2 per cent or more - and that's before fees.

It raises the question of whether investors get value for money when they invest with active fund managers, when so few deliver.

Investors entrust their money to active managers because they trust the experts to, over time, deliver higher returns than that of the general market. If they don't, they're not earning their fees.

Most managers tell funds researchers their targeted "excess" return. Of course, that's no guarantee of future performance, but it does at least tell the researchers what the manager is hoping to do for investors.

The table lists 17 international shares funds that are available to Australian retail investors. The targeted excess return is given in the first column. The actual returns are listed in the next column. The excess returns are those in excess to the MSCI, which returned an annualised minus 4.4 per cent for the five years to December 31, 2003.

The results make for sobering reading. Only eight out of the 17 have managed to meet or do better than their targeted excess returns.

Almost half of the managers failed to meet their stated objectives. But for investors, the true position is worse, because the excess returns given in the table are before investment management fees are accounted for.

Managers charge investment management fees of between 0.9 and 1.3 per cent on their international share funds when they are offered to investors through platforms such as master trusts and wrap services.

After allowing for the investment management fees (let's ignore the platform fees and adviser fees, which all add up), the number of funds in the table that meet the performance objective falls from eight funds to just five. That's five out of 17.

To be fair to the active managers, the past five years have been particularly difficult ones. They have had to contend with very volatile markets, with marked swings in the types of stocks that have done well.

On top of this, the Australian dollar, which first plunged to just over 48 US cents and then rose to almost 80 US cents over the past three years, has also introduced extra challenges. As the value of an international shares fund is given in Australian dollars, and with perhaps more than half of most funds invested in US shares, that's made it even harder for managers to perform.

The best performer over five years has been Credit Suisse, with an average annual excess return of 6.57 per cent. It outsources its stock selection to a US fund manager, Capital International.

Credit Suisse in Australia is able to run a currency overlay on the Capital fund of up to 50 per cent. It has hedged the US dollar and the Japanese yen exposure up to the maximum 50 per cent at times during the past five years. That strategy has accounted for more than 1 per cent of the 6.57 per cent return, with the remainder coming from stock selection. Most other managers are much less active in currency management.

Global shares funds: Half fail to deliver
There are alternatives to index-relative managers. One is to reject altogether the notion of "active" management. That's because the chances of finding one that can deliver returns to justify the fees over a long period are slim.

There are index managers that charge lower investment management fees because they simply track or mirror the market index.

Index fund managers have not proved that popular with financial advisers.

It is believed that one of the reasons for a lack of adviser interest in index funds is that they do not pay trail commissions, or pay only small ones, to financial advisers.

US giant Vanguard Investments has the biggest retail presence in index funds in Australia. The Vanguard Index International Shares Fund charges an investment management fee of 0.9 per cent (less for amounts of more than $50,000).

Another advantage, apart from low fees, is that the transaction costs (such as brokerage) are lower than for actively managed funds.

Anyone investing in a shares fund should be taking a long-term view - at least five years. Just being in an international shares index fund for the past five years would not have saved the investor from negative returns, with the annual average return for the past five years to the end of December 2003 of worse than minus 4 per cent. Over the year to the end of February 2004, the index is up by more than 13 per cent, which underlines the volatile nature of global stockmarkets.

There are other alternatives to the 17 given in the table. A couple of boutique managers invest the money in a way that is benchmark-blind.

They take the usual long positions as well as short positions, which is a way of making money when a share's price falls. They take very active positions on currency and can hold high levels of cash if they cannot find sufficient buying opportunities - perhaps because they think share prices are too high.

The long/short managers - the best-known being Platinum Asset Management - are not included in the Lonsec table.

Platinum's International Fund has produced an average annual return for the five years to December 31, 2003, of 20 per cent. That's no misprint - in that time it outperformed the index by more than 24 per cent. Lonsec says Platinum is a hedge fund manager (a term, by the way, that Platinum rejects).

Lonsec says that to include long/short managers with long-only, index-relative managers, would be misleading to investors.

Grant Kennaway, Lonsec's general manager of research, says the survey shows just how difficult it is for manager of international shares funds to meet their objectives. He is running the same numbers for Australian shares funds. While they're not complete, he suspects that they are likely to be finding it easier to beat their benchmarks than their international shares counterparts. That's because

the Australian stockmarket, particularly among the smaller companies, is not that well researched and skilled managers can capitalise on that lack of research.

But when it comes to international shares fund managers - at least the actively managed, index-relative managers - Kennaway thinks investors should consider alternatives. "When you see managers struggling to beat the benchmark, you can see that perhaps index funds have a role to play," he says. Kennaway says that the international shares funds of some boutique long/short fund managers have "smashed the benchmark" over the past five years.

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