Shares crack whip in funds

Some managed funds have performed well in the past year thanks to market recoveries, writes John Collett.

It's been a very good year for share-based managed funds and their investors. Australian shares, including dividends, returned more than 20 per cent for the year to June 30. Global shares rose by more than 33 cent. And fund managers have been making hay, with plenty beating market returns by 10 percentage points or more, after fees.

Australian shares

In Australian shares, the best performers for the year have been those fund managers underinvested in the mining sector and overinvested in a handful of the higher dividend-paying stocks, like the banks and Telstra.

The slowing of China's economy continues to be a drag on commodity prices and on the earnings of mining companies. Small resources companies and those that are providing mining services have had a particularly poor year. High-dividend stocks have done well as investors chase yield as interest rates fall.

The Smallco Broadcap Fund is the outstanding performer in Australian shares, with a return of more than 50 per cent over the year to June 30. This is a "concentrated" fund that holds between 20 and 30 stocks. Up to 40 per cent of the fund can be invested in smaller companies - those outside the 100 biggest companies. The fund is under market weight in resources stocks and almost out of mining services stocks altogether, which has helped the performance of the fund over the 12 months.

"But the main driver [of returns] has been a high hit rate in our stock selection process," says Andrew Hokin, senior portfolio manager for the Broadcap Fund. "In the past 12 months we have had 19 positions totalling nearly 70 per cent of the portfolio that outperformed the market by more than 10 percentage points." Big contributors to the performance of the fund include News Corp - now 21st Century Fox after News Corp split into two - fund manager Magellan Financial Group and online property advertising business REA Group.

"It's fair to say that market conditions have suited our style, given the underperformance of resources and the market focus on quality stocks," Hokin says. The fund has been going for about five years and has an average annual return of about 20 per cent over that time.

Naos Long Short Equity Fund is in second spot, with a return of just under 45 per cent. It holds between 10 and 15 stocks. A big winner for the fund is Village Roadshow, Australia's largest theme park operator. It is developing a Wet'n'Wild water theme park in Sydney's west that will open this year. "It is a good defensive stock and the opportunities for the Sydney theme water-park have been poorly understood by the market," says Sebastian Evans, portfolio manager for the fund.

Ingenia Communities Group, which develops, owns and operates seniors' housing, is another good performer for the fund. "It is an excellent business with an excellent management team," Evans says. The fund can also "short" stocks, which is a way of making money when a share price falls. Bennelong's Concentrated Equities Fund has returned almost 34 per cent over 2012. "We are quite particular in what we invest in and like to take big bets," Mark East, the chief investment officer at Bennelong Australian Equity Partners, says.

"We do not want to take big bets on anything; it has to jump through a lot of hoops," he says. The fund invests in healthcare, such as blood-products maker CSL and medical devices company ResMed. Another factor in the good performance has been underinvesting in the resources sector.

Companies attracting online advertising have done very well for investors in the Hyperion Australian Growth Companies Fund, which returned more than 33 per cent for the year. The fund has share holdings in real estate online advertising business REA Group, online jobs with SEEK and car advertising through carsales.com.au. "We invest in high-quality businesses with high return on capital and sustainable competitive advantages," says Joel Gray, a portfolio manager of the Hyperion Australian Growth Companies Fund.

Global shares

PM Capital's Absolute Performance Fund is the outstanding performer in global shares. The fund returned more than 62 per cent over the financial year, a 20 percentage point lead over the second-place getter.

The Sydney boutique manager has played (and still is playing) the recovery in house prices in Las Vegas. The city was the epicentre of the downtown in US house prices that triggered the global financial crisis. Paul Moore, who founded the manager in 1998, is not expecting a repeat of such an outstanding return this financial year, but the recovery in US house prices still has a long way to go, he says. The fund holds shares in US banks with big mortgage books that would benefit from a housing recovery, such as Wells Fargo, Bank of America and J.P. Morgan. Another holding is Howard Hughes Corporation which, among its activities, is developing Summerlin, a planned community on the outskirts of Las Vegas. PM Capital's fund also has a position in MGM Resorts International, whose portfolio of businesses includes casinos in Las Vegas.

Templeton Global Equity Fund is in second place in international shares, with a return of 42 per cent. Peter Wilmshurst, the lead portfolio manager of the fund, says: "We search the world for bargains and we are happy to look up and down the market capitalisations and across most industries." The fund has done well from its holdings in the healthcare and financial sectors, he says.

Healthcare, pharmaceuticals and biotechnology were out of favour three or four years ago, Wilmshurst says. Everyone was talking about the "patent cliff", where a lot of drugs would be no longer protected from competition from generics. "That helped drive valuations down [of pharmaceuticals companies], which we thought were ridiculously cheap," he says. The fund owns many of the big brands in pharmaceuticals and their share prices have done well over the past three years. European financials have done well for the fund after the manager bought shares during the worst of the financial crisis. The fund has done well from its holdings in the London-listed Lloyds Banking Group.

Jason Ciccolallo, head of institutional business at Orbis Investment Advisory, whose Global Equity Fund came third with a return of 41 per cent, says funds management is a zero-sum game. "And for us to win, someone else has to lose.

"We are a contrarian investor; we tend to buy things that are ignored or, even better, hated," he says. The biggest contributor to the fund during the financial year is Micron Technology, a US sharemarket-listed computer memory maker. There has been industry consolidation, with Samsung left as its major competitor. The second-largest contributor is Barclays, the British bank.



Top picks in Australian shares

Andrew Hokin, Smallco

21st Century Fox

REA Group

Capitol Health

Sebastian Evans, NAOS

APN News & Media

Village Roadshow

Capitol Heath

Mark East, Bennelong

21st Century Fox

Flight Centre

Super Retail Group

Joel Gray, Hyperion

REA Group

SEEK Limited

Carsales.com.au



A warning on short-term returns

Investors have to be careful about putting too much credence in short-term performance. Markets rarely do back-to-back financial years like the one just ended.

While it was an outstanding year, fund managers say it is going to be harder to generate similar returns this financial year. They say it is more difficult to find quality stocks at reasonable prices than it was a year ago.

Morningstar co-head of fund research Chris Douglas says: "The performance ranking of fund managers can change quite dramatically from year to year."

This year's best performer can be next year's worst-performing manager, he says. This is because they have different approaches, meaning market conditions at any time will favour one manager over another. "Investors have to be careful not to be buying into yesterday's winner that could easily be tomorrow's loser," Douglas says.

Anyone investing in shares through a managed fund would want to be investing for at least five years. They need to consider the manager's returns over at least this time frame to see how the manager performs through market cycles.

"When you are investing in managed funds, you are making a forward-based judgment," Douglas says. "If past performance is the sole basis for investing in a fund, there is a much higher risk of getting that decision wrong."

For performance numbers, forward-looking analyst ratings and commentary about fund managers, see morningstar.com.au.