Index-trackers show up underperforming fund managers

After the GFC flattened retirement savings around the world, shareholders dumped equities and fled to the safety of government bonds. Even more money went to cash, where it remains to this day, awaiting the Return of the Sharemarket Boom.

Meanwhile, those courageous souls who still want exposure to equities markets have increasingly turned to passively managed funds, which seek not to beat the market but to match a given index at the lowest cost. The unlisted versions of so-called "index" funds have been around for some time, with Vanguard the biggest global name. But in the past five years or so it's been their ASX-listed cousins, known as exchange-traded funds, or ETFs, that have enjoyed the limelight.

For the cost of brokerage, you can buy units in, for example, the SPDR 200 Fund (ASX code STW) and in one fell swoop gain exposure to all the stocks in the S&P/ASX 200 index. That also provides an instant level of diversification that can be expensive and time-consuming to re-create in your own portfolio. For all that, you pay an ongoing management fee of only 0.286 per cent. There are now 77 ETFs listed on the ASX that track a variety of indices across local shares, global equities, bonds, commodities and currencies (see graphic, above).

DO THE PROS BEAT THE MARKET?

Standard & Poor's head of research, Leanne Milton, says a good active fund manager should be able to beat the market over an investment cycle of three to five years. And no doubt there are some quality funds out there, such as the Clime Australian Value Fund or SG Hiscock's SGH20 Fund. But with hundreds of actively managed funds on offer, identifying the "good" manager from the average or just plain bad is as challenging a prospect as picking a winning stock.

Here's a tip: don't put your money in funds that invest solely in the biggest listed companies. These "large-cap" funds have a terrible record when it comes to beating the market. Only 38 per cent beat the benchmark S&P/ASX 200 index over three years, and 59 per cent over five years, according to exclusive data supplied by Standard & Poor's to Smart Investor Money. Those are not good numbers.

One financial planner recently told our sister publication Asset magazine he calculated some popular large-cap Australian equity funds have a correlation to the market of as much as 96 per cent, which means you are paying an extra 60 or so percentage points in management fees for what is essentially an index-tracking fund.

It's a very different story when it comes to professional stock pickers operating in the shallower end of the pool. Every single small-cap fund manager analysed by Standard & Poor's beat the S&P/ASX 300 Small Ordinaries Index in the past three and five years.

DIY STRATEGY

Academic research suggests that asset allocation accounts for about 80 per cent of overall returns, which means you should spend a lot more time deciding how much money goes into which basket - generally shares or bonds - rather than agonising over the relative merits of investing in BHP or Rio Tinto. But bonds have traditionally been difficult for individuals to invest in - they tend to only sell in very large denominations, and the process can be complicated. Getting a diversified exposure was even harder.

The recent introduction of a number of fixed-interest ETFs that invest in Australian government or corporate debt has changed all that. You still need to "look under the hood" of these funds - and across all the asset classes - to make sure you are getting the exposure you want. For example, government bonds are safest, while corporate credit will be higher risk (and return).

There's always room for paying for expert help when managing your money - it's a complicated and challenging endeavour. But don't immediately assume you need to leave everything to the professionals - the tools to implement your investment strategy are at your fingertips.