NZ Herald 25 April 2020

AAccording to the Oxford dictionary, a 1659 collection of English proverbs included “No weeping for shed milk”. These days we cry rather than weep, and the milk is spilt rather than shed. But the meaning hasn’t changed. Take note of it.

What’s more, you’re not just cleaning up the mess, you’re obviously learning from your mistake. So no more beating yourself up, okay!

One of the main things you, and a whole lot of others, have learnt recently is that you’re not good at coping with a falling sharemarket. I’m hoping, though, that you and your nervous mates also learn over the next year or two that the long-term market trend is upwards, and it’s best to ride out a downturn.

However, you’ll probably never be one for higher-risk funds. So your plan to put your longer-term savings into a moderate fund is sound.

When should you move back? You say after six months “if the market stabilises”. But how will you know? We all tend to assume whatever has been happening lately will probably continue, and that’s fair enough with many trends. But not share prices.

I suggest that, regardless of what’s been happening, you move your savings back into KiwiSaver in, say, three steps money — a third in six months, a third maybe a month later and a third two months later. That avoids moving it all at what turns out to have been a particularly bad time. But don’t muck around for too long. Get in there for the higher long-term growth than in term deposits.

On your last paragraph, here’s the deal. If I tell you where you can watch the progress of the New Zealand and world sharemarkets, do you promise you won’t try to time your re-entry to KiwiSaver, or any other investment moves? I hope every other reader makes a similar promise.

Okay, here’s where to find the graphs:

• The NZX50 is here
• The MSCI world share index is here

You can look at different periods. “YTD” — year to date — is a good period to see what’s been going on under Covid-19.

For others wanting to check their risk profile, go to the KiwiSaver Fund Finder on www.sorted.org.nz and click on “Find the right type of fund for you.”

ABig jump. Clearly more New Zealanders are suddenly taking an interest in the share market.

Why are more individuals buying than selling? I asked NZX. “We don’t have any visibility into the individuals, but an unverified theory could be that those buying are holding as an investment.”

But every trade needs a buyer and a seller. So who has been selling more than buying? Wholesale investors, buying for an organization rather than for their own personal account. They include KiwiSaver and other managed fund providers, pensions and so on.

That doesn’t mean there’s been a huge selling rush from wholesale investors, though.

“Retail investors typically trade in much smaller amounts than institutional investors,” says an NZX spokesperson. “So it wouldn’t necessarily mean there is any large selling activity from somewhere else.”

AFair question. Jayne Russell, MSD’s group general manager employment responds:

“Applicants for the wage subsidy should take active steps to mitigate the impact of Covid-19 on their business activities. We would expect applicants who have significant cash reserves to have considered using these before applying for the wage subsidy.”

But many small business owners may not have money labelled “cash reserves”.

Adds Russell, “For a self-employed person who does not have a clear separation between their business and personal finances, it may be that considering personal finances is appropriate, especially where they had planned to spend that money on their business.

“We expect people in this situation to assess what are cash reserves for their business and whether using them would be appropriate in their particular situation in order to apply in good faith.”

It seems you don’t have to have cleaned every last penny out of every personal account before applying.

AYes to your first question, and no to your second one.

Managers of active share funds — in and out of KiwiSaver — select which shares to hold, and when to buy and sell them, while managers of index funds simply buy all the shares in a market index, such as the NZX50.

Index funds — sometimes called passive funds — are much cheaper to run, and therefore charge lower fees. This helps them to perform better than most active funds after fees, over the long term.

But, as you say, active managers can choose to avoid certain industries.

The trouble is that by the time a manager realizes prospects for an industry have deteriorated, it’s probably too late.

Picture the managers of a whole lot of NZ active share funds, which until recently probably had considerable holdings in tourism, hospitality and aviation shares because that’s where a lot of the growth was.

At the very first word about the discovery of Covid-19 in China, maybe one or two of those managers predicted the trouble to come, and quickly sold some of their shares in those industries — although selling in a hurry they may not have got great prices for them.

Other managers would have seen the price falling, and perhaps rushed to sell their shares — but at increasingly lower prices.

Since then, the New Zealand and world share markets have been rebounding. Last I looked world shares were halfway back to their February high, and local shares were more than halfway back.

That seems weird when the economic outlook is bleak. But perhaps share sellers overreacted in early and mid-March. Or perhaps we’re in for more falls. Nobody knows. We do know, though, that some time in the not too distant future shares will be back on their long-term growth path.

And at some point, many active managers will find themselves buying back some of those shares they sold — quite possibly at higher prices than they sold for. That’s not a winning strategy — especially when you consider trading costs.

There’ll be other shares they stay out of — possibly including some that later do a surprise phoenix performance, and the managers miss out on dramatic gains.

Meanwhile, index fund managers, with no choice, have just kept holding the shares right through — apart from making what are usually relatively minor changes when their index changes, usually once a quarter.

I’m not saying no active managers would have handled the turbulence well. Of course some have. But will they always be the winners?

Remember that investing in shares or a share fund is a ten-year-plus proposition. It’s too risky to put shorter-term money in shares, because you can lose money over short periods — as we’ve seen lately.

So let’s look at ten-year performance. Quite a lot of active share funds do so poorly they don’t last ten years. Others do well some years, badly in other years. And there are usually a few that shine.

But there are at least three reasons why they might not stay at the top:

• Their star stock pickers are enticed away to other funds. And we don’t know they’ve gone.
• The fund attracts many investors and becomes too big. As Dean Anderson of Kernel said last week, “If you’ve got a billion dollar fund and the market starts to fall, you can’t just turn 40 per cent of it into cash easily.”
• The managers might have taken more risk than most funds — which works well sometimes and badly sometimes.

Very long-term studies show the winning funds in one decade often perform poorly in the following decade.

Even if one fund keeps outperforming, how do you know in advance which one? It’s a better bet to go with a low-fee index fund, regardless of what’s happening to the markets at any time.

AGood point. If an index fund holds the shares in a market index, it should perform the same as that index, but a bit worse because of fees — albeit low fees.

And yet last week I quoted someone from Smartshares — the largest New Zealand-based manager of passive funds — as saying in a magazine interview that in the October 2018 market downturn, “Only two of the 19 NZ active equity (share) funds beat the market, according to Morningstar, but all of our funds did.”

Actually, he forgot that one of Smartshares’ five NZ share funds, its Top 10 fund, didn’t do so well, dropping a bit more than the average active fund in that quarter. More on that fund in a minute.

But to your point about beating the market. In New Zealand, “the market” is usually regarded as the NZX50 index, which includes basically the 50 biggest shares.

But no Smartshares’ index fund is based on that index. The Top 10 fund holds just the biggest ten shares, the High Dividend fund holds 25 shares that pay higher dividends, and so on.

The one closest to the NZX50 is the NZX Top 50 fund, but it’s based on the Portfolio Index. This caps each share at 5 per cent of the index, whereas the main index is based on “market capitalisation” — the total value of each company’s shares. So a really big company has a really big weighting. For example, Fisher & Paykel Healthcare and a2 Milk currently make up about a quarter of the index between them.

As it turned out, in the 2018 downturn all the indexes used in Smartshares funds — except the Top 10 mentioned above — performed better than the NZX50 index. Hence last week’s quote.

That’s not always the case of course. In the recent downturn — in the month and year ending March 31 — most of Smartshares’ NZ share funds performed worse than the NZX50, and worse than most active funds. Oddly enough, though, the very one that did worse in 2018, the Top 10 fund, was easily the best performing NZ share fund in the year ending 31 March 2020, and second best in the month of March.

What’s more, “Smartshares US Large Growth ETF was the best performing fund out of all 685 managed funds in New Zealand over the last one year and three years to 31 March 2020,” says a spokesperson. “Despite the drop in markets this fund returned 16.64 per cent net of fees over the 12 months to 31 March, and 16.07 per cent a year over the last 3 years.”

So what’s going on here? In market downturns, some index funds do well and some don’t. Ditto for active funds. The main point is that active fund managers have long said, “Index funds are all very well, but wait for a downturn.” Here we are in a downturn, and some index funds are more than holding their own.

ANot sure I accept that my preference for passive funds is a bias. It arises simply from decades of watching.

No, Kernel NZ20 is not a KiwiSaver fund, although I don’t think that affects anything. And yes, it is a higher-risk investment than Milford’s Active Growth Fund, because the latter includes some lower-risk assets such as bonds. But as I pointed out last week, you would therefore expect the Milford fund to be less affected by the share market drop, but that wasn’t the case.

You’re right that the Kernel fund benefitted from the strong performance of F&P Healthcare and a2 Milk. That’s because that fund’s index is another one based on market capitalisation — like the NZX50 described above.

Which leads to your question about market “cap” indexes. I asked Dean Anderson of Kernel why he used such an index. “The beauty of market cap indices is their true reflection of the market. As companies do well, they grow in value and shift up the index, as they do worse they become a smaller part of the index and eventually drop out. Ultimately, when you invest in a market cap index fund you are buying the market, or part thereof.”

I agree to some extent. But when just a few companies dominate an index, that can be worrying. If they do badly, the fund probably will too. Personally, I prefer a fund based on an index like the Portfolio index, also described above. Its 5 per cent cap prevents such dominance.

Good luck with finding active managers that keep performing well. They are rare.

AAny time is a fine time to switch provider. If you move to a fund with the same risk, losses are not an issue. If you sell low, you then buy low.

But if you want to raise or reduce your risk at the same time, I suggest you first move to a same-risk fund, and then gradually change your risk level a bit at a time — as described in today’s first Q&A.

This is a good time for everyone to review their KiwiSaver settings. It could make a big difference in the long term. I wrote about how to do it a few weeks ago.

Oh, and yes, I’m bubbling along fine thanks — and loving the way most people are friendlier than usual. Let’s keep that going long after this crisis is over.