Do new funds deliver better performance?

Ahead of Livewire’s Undiscovered Funds Series I look at the growth in the Australian managed funds industry and data on new market entrants.
Sara Allen

Livewire Markets

New funds typically fly under the radar for a range of reasons. After all, the early years of a fund are typically when the fund manager is building up a track record, has no research rating and little marketing budget to promote the strategy. The research on fund performance in the early years is mixed. Some suggest that the early years are where a fund is likely to see its greatest outperformance, while others show variation, with market activity the biggest factor.

Either way, new funds could be more than worthy of an investor's time and interest, if only they knew where to look and how to evaluate these in absence of performance history.

There are also more new funds out there than investors might realise. 

In the last three years, close to 700 new managed investment schemes were registered with ASIC. 

In fact, 50 new managed investment schemes have already been registered in 2023 - we're only at the start of May. 

It's worth noting that over 10% of those nearly 700 new schemes previously mentioned have since deregistered for a range of reasons.

While the number seems staggering, it shouldn't really be surprising. The Australian funds management industry is a highly attractive space for onshore and offshore managers. It grew more than 12% in the three years to December 2022. 

Our compulsory superannuation scheme is one of a number of drivers behind this. Superannuation represents over 75% of the $4.4tr in assets under management in managed funds, and this number will continue to grow courtesy of population growth and changing legislation on required payment sizes.

In this wire, I’ll explore starting out in the Australian managed funds industry and the research around emerging funds and managers.

Managed Funds by the numbers

  • 684 - the total number of new managed investment schemes registered with ASIC in three years. (Source: ASIC supplied data. 1 Jan 2020 - 31 Dec 2022)
  • $4.4tr – total assets under management for the managed funds industry (Dec 22) (Source: ABS)
  • 21.7% - portion of AUM invested in overseas assets (Source: ABS)
  • 50% - the amount of AUM managed by just 10 fund managers (Source: Plan for Life)
  • 4.6% - average annual growth in the number of new fund manager entrants to the market (Source: Plan for Life)
  • 73 - the number of new managed investment schemes in the last three years which were deregistered with ASIC by 4 May 2023. (Source: ASIC supplied data)

Getting started in the industry

Despite the growth, don’t assume it’s easy to register and launch a fund in Australia.

Prospective fund operators need a financial services license and be a registered Australian public company before they can register a managed investment scheme. To register a scheme with ASIC, a fund manager needs to provide copies of the fund constitution, a compliance plan and director statements.

But that’s not the end of it – after all, there’s no fund to manage without money.

Fund managers need an initial ‘seed’ investment to start the strategy going. This could be their own resources or may come from a company sponsor or institution. Finding such a starting investment is obviously going to be easier for fund managers launching a new strategy from an established funds business, followed by experienced fund managers with existing networks to lean on setting up their own businesses.

This is all at the start. 

Assuming a fund manager has made it this far, they still need to encourage more investors to invest in the fund – and often as not, the key to this is building a track record. These things take time.

A small matter of track record

A study from the World Economic Forum found that track record consistently features among investor’s top criteria for manager selection. Typically, investors take this to mean medium- and longer-term performance – after all, we are encouraged to look beyond short-term data in making comparisons and researching.

But should investors fear the shorter-term performance of newer managers? 

Some studies suggest not.

  • Huang, Jie and Ma 2022 looked at hedge fund managers and noted that performance peaked at 5 years and began to deteriorate afterwards. It also noted female fund managers and fund managers with PHDs had substantially better Sharpe ratios (risk ratios).
  • A Prequin and 50 South Capital report in 2019 found that hedge funds in early lifestyle outperformed more established by around 4% a year with only modestly higher risk involved.
  • Research from the Australian Fund Monitor across 400 actively managed equity funds and absolute return funds in 2018 found that funds typically performed better in their early years of operation. The data averaged 16% returns in the first year of operation before dropping down in later years.

Some factors that may be driving this earlier success include the focus of the management team purely on investment rather than marketing and desire to ‘prove’ the strategy.

Perhaps getting in earlier means an investor has more exposure to that initial pure investment focus?

It’s also worth noting that many such studies like the above have a success bias – those funds that fail in the early stages tend to miss being included.

Markets matter though....

Livewire asked Australian Fund Monitors to revisit their data for the three years to the end of 2022 to see if the same 2018 results still held. This time, there was far greater variation in performance and no clear outperformance for early stage compared to later stage funds.

Chris Gosselin, CEO of Australian Fund Monitors, argued that market context changed the game. 

"The new funds in the 2018 data benefitted from a strong post-GFC market, whereas it has been extremely volatile in the last five years. There's been so many variables, like the covid pandemic, the war in Ukraine, the tech burn and the pushback from years of quantitative easing," Gosselin said.

The key pain was for Australian small cap equity managers, while alternatives managers tended to perform better in the volatile markets on the whole.

Performance based decisions

While the studies are mixed in assessment of early performance, it's dangerous to pin your hopes on outperformance. After all, there is a reason for that old legal chestnut 'past performance is not a reliable indicator of future performance'. But don't take the lawyers' word for it, just look at some of the data:

  • An ASIC analysis found little correlation between past good performance and future good performance in funds – but it found a strong correlation between poor performance in the past and future. Poor performance is also a strong indicator of future fund closures. So it’s still worth looking at past performance, but not necessarily for the reasons you think.
  • The S&P SPIVA scorecards found that any outperformance from a fund manager is typically short-lived. No fund manager that made it to the top quartile lasted there for five consecutive years.

Your key takeouts from these?

  • Consistent long-term poor performance is actually a very reliable indicator of future (poor) performance. 
  • Today's top performer is unlikely to be tomorrow's top performer.

What should track record really mean if not performance?

The earlier mentioned study from the World Economic Forum suggested track record should be viewed as a broader piece. 

It suggested manager specific qualities offer a better picture for track record, such as talent of the team, investment philosophy and platform.
It’s one approach you could use if you are considering emerging managers and have little performance history to analyse strategy and philosophy. 

Another way of looking at track record is thinking about consistency in application of strategy and mandate. In fact, one study suggested that it was key to longer term success. 

Detzel and Howard 2021 analysed funds with similar investment philosophies and strategies and looked at how consistent application affected performance. For example, if value managers with similar criteria identified the same value stock, it tended to indicate closer alignment with their stated mandate. The study found that those fund managers who were inconsistent in the application of their mandate were more likely to underperform their benchmarks. 

What this might mean in terms of evaluating emerging funds is comparing portfolio holdings with other similar strategies to gain an understanding of how closely the fund manager is sticking to the strategy and mandate.

Should you invest in new and emerging fund managers and funds?

There's a growing world of talented new fund managers and funds out there so avoiding them purely on the basis of long term performance track record might be a disservice to your portfolio. 

In our upcoming series 'Undiscovered Funds', we're going to speak to a range of experts about how to research and analyse such investments for your portfolio and introduce you to some of the emerging talent in the Australian market right now. In the meantime, let us know if you invest in any new and emerging funds and what you like about them in the comments.

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Sara Allen
Content Editor
Livewire Markets

Sara is a Content Editor at Livewire Markets. She is a passionate writer and reader with more than a decade of experience specific to finance and investments. Sara's background has included working at ETF Securities, BT Financial Group and...

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