Russell Investments has lashed “easy beat” NZ retail fund benchmarks while backing the ‘reference portfolio’ model for most diversified strategies.
In a new research paper, Russell calls out common benchmarking methodologies for both NZ single asset class funds – particularly cash-plus products linked to performance fees – and diversified portfolios as inappropriate and likely skewed against retail investors.
“As an advisor to global investors and a researcher of fund managers, we have a front row seat to performance benchmarking practices,” the report says. “Whether due to carelessness, ignorance or something more sinister, we believe that benchmarking practices of local fund managers, asset owners and wealth managers often times fall short of global best practice.”
According to Russell, most single asset class funds should be tracked against established “independently calculated and representative indices” rather than cash-plus or other manager-constructed benchmarks.
“Benchmarking of single asset class, fully invested and liquid (‘traditional’ or marketable securities) portfolios and funds should be straightforward, but we find that local practices often end up serving fund managers far better than their clients,” the paper says.
For example, the Russell analysis found many NZ equity funds have cash-linked performance targets of 3 or 4 per cent in recent years despite long-term average returns for shares ranging from 8 to 9 per cent.
The recent Financial Markets Authority crackdown on benchmarking and performance fees as part of its value-for-money campaign has seen some managers remove or tinker with performance fees.
“Nonetheless, we see no reason why performance fees should be so common locally, when in other large markets they are seldom found in simple, long-only funds for retail, ‘mum and dad’ investors,” the report says. “We find no evidence that local investors have benefitted from the widespread use of performance fees in retail managed funds.”
And many diversified funds in NZ, including KiwiSaver schemes, often use hand-crafted ‘composite’ benchmarks that are difficult to verify or calculate, the Russell study says.
“For the many retail investors in diversified funds, e.g. the three million-plus KiwiSaver and retirement scheme members, the composition of fund benchmarks, as well as their historical asset mixes, are essentially inaccessible, incomprehensible, uninvestable and therefore utterly meaningless.”
The paper, authored by Russell NZ director, Matt Arnold, suggests the majority of diversified funds should follow institutions such as the NZ Superannuation Fund by adopting the ‘reference portfolio’ model – comparing returns against a “notional” portfolio of low-cost passive investments that broadly match the asset allocation of the strategy in question.
“We suggest that, at a minimum, all multi-asset investors should compare their portfolio outcomes relative to those generated by a straightforward Reference Portfolio on a regular basis,” the Russell study says.
Titled ‘Making everyone look good? How ‘easy beat’ benchmarks distort the market (and what to do about it)’ is the first installment of a two-part Russell benchmarking blast with the sequel to address KiwiSaver, specifically.
“We suggest regulatory objectives, as well as fund manager, financial adviser and member requirements are not being met by current practices and propose a better alternative – simple KiwiSaver Benchmarks,” the paper notes.