Fund Spy: What high fund outflows tell you, and what they don't

Active fund managers have been under the pump for some time, and while the following lists show which managers and funds have lost the most investor money, there are still many reasons to like them.

A recent Morningstar article on dividend-yielding stocks drew attention to two prominent fund managers, Perpetual and Pendal Group.

Morningstar equity analysts applaud their income characteristics but warn that these asset managers also face challenges.

In his latest research note, equity analyst Chanaka Gunasekera notes they are both losing investor money from a combination of outflows and lower performance fees.

And they're not alone in this – many active fund managers globally are under pressure, not least because of the intense competition from low-fee passive funds.

We’ve used Morningstar Direct to identify the 10 highest outflows in the year to 30 June 2019 among actively managed Australian equity funds.

Before we reveal which funds have led the outflows, a few points on our methodology.

Firstly, there are several reasons behind fund outflows, some more concerning than others.
Senior staff changes at funds, underperformance, high fees: these are just some of factors behind the movement of investor money, says Morningstar manager research analyst Michael Malseed.

"A more benign reason could be that the fund has been around for a long time, and the investor base has moved from accumulation to drawdown phase," he says.

Two of the biggest things to look out for when a fund is experiencing high outflows are:

• Will the firm remain profitable with declining funds under management, and is there a risk of the strategy or firm shutting down?
• Are the fund's underlying assets liquid enough to ensure it can continue to service the redemptions – if there is a rush for the exit on an illiquid fund, redemptions may be gated, meaning investors may not get their money out in time.

There will always be winners and losers, and there are still plenty of high-performing active strategies that are attracting investor money - Magellan's global strategy is a prime example.

But he believes holding managers to account for the fees charged versus the services they are delivering is a positive trend."We expect scrutiny on fees and net performance to continue, and it is a key part of Morningstar's ratings process," says Malseed.

Some commentators suggest that active managers will come to the fore once again as the market downturn rolls on. But this isn't necessarily true - investors who have shifted a portion of their assets into passive strategies are unlikely to swap back simply because benchmarks are underperforming.

On the other hand, Malseed says that active managers who struggle to outperform will always be at risk of losing money to passive strategies.

"But we also expect the best active strategies to be able to outperform over a full cycle. The ability to offer downside protection is an important factor when considering active strategies, and historically in a market downturn the better managers have proved their worth," he says.

Across fund families, the top 10 outflows feature those funds with the largest pools of investor money. A number of these are also rated very highly by Morningstar analysts - further proof that outflows aren't necessarily a sign of impending doom or bad performance.

Highest manager outflows over year to 30 June 2019

Source: Morningstar Direct

Another fund manager alluded to earlier, Pendal Group, ranked outside of this top 10 of outflows, having waved goodbye to $55 million of invested capital in the 12 months to 30 June 2019.

Broken down into individual funds, the list looks like this:

Highest fund outflows for year ended 30 June 2019

Source: Morningstar Direct

Fidelity Australian Equities

Fidelity Australian Equities (12292) holds a Morningstar Gold medal. Morningstar senior manager research analyst Andrew Miles has long been an admirer of portfolio manager Paul Taylor as one of the most distinguished investors in the market.

The fund holds positive ratings across four of the five pillars that underpin our analysis - process, performance, people and parent – falling down only on price, which is rated as neutral. But with a management fee of 0.85 per cent per year and no performance fee, Miles finds this is largely in line with other local large-cap equity managers. This fee has been at the same level for at least 10 years.

Yarra Australian Equities

Yarra Australian Equities (4544) holds a Morningstar Silver, rating positive across process and people, and neutral for performance, parent and price.

Spun out of Goldman Sachs three years ago, when the global group decided to exit asset management in Australia, the fund itself doesn't have a long track record. But Morningstar senior manager research analyst Ross MacMillan notes the team is eminently experienced, having previously been part of Goldman Sachs.

MacMillan says that the people that run a fund and the process they follow are some of the most important aspects his team assess in rating funds.

Pengana Australian Equities

Pengana Australian Equities (18190) holds a Neutral Morningstar rating. Manager research director Alex Prineas cites some key weaknesses, particularly its high cost – which may be partly responsible for its high rate of outflows.

He awards it a negative for the Price pillar, regarding its annual base fee of 1.025 per cent as "pricey" given its high cash and bond holdings. But the performance fee is the biggest pricing concern: 10.25 per cent if three conditions are met – returns must exceed the RBA cash rate, providing the total net performance is more than the RBA rate, and a high-water mark must be achieved.

"We do not believe this is best practice and would prefer a higher performance fee benchmark / hurdle rate," Prineas says.

Perpetual Wholesale Australian

Perpetual Wholesale Australian (4361) holds a Morningstar Bronze, rating positive for three out of the five Ps - process, people and parent.

In those where it screens as Neutral – performance and price – Morningstar notes the fund's performance was hurt in previous years by being underweight resources, contributing to the fund trailing the index in both 2017 and 2018.

The fee of 1.01 per cent – which has been bumped up from 0.99 per cent since 2016 - is regarded as just about average.

Perpetual Wholesale Share Plus L/S

Another Perpetual fund, Perpetual Wholesale Share Plus Long/Short (41394) is rated Neutral overall by Morningstar, with a positive rating only for the parent category. The fund is rated neutral across process, performance and people and negative on price.

MacMillan says the fund's approach is differentiated, "but it still has a long way to go in proving its overall credentials through the full cycle".

He notes that cash levels can run as high as 25 per cent and the fund has a propensity for aggressive stock bets, with a maximum of only 40 stocks.

And on fees, MacMillan regards the fund as relatively expensive, with a base fee of 1.1 per cent and an additional 15 per cent performance fee for net returns above the MSCE World Net Total Return Index.