David Paradice, one of the country’s most respected investors, says he expects more Australian money managers will be forced to close after a long stretch of bad performance pushes clients toward cheaper index-trackers, and as retirement savings funds stop using external advisors.
Paradice, who founded Paradice Investment Management in 1999 and has grown the boutique into a $20 billion powerhouse, said government-imposed tests on super funds had also increasingly pushed fund managers to take fewer risks, fearing they would lag the broader market.
Changes implemented by the Morrison government in 2021 placed annual performance tests on super funds. Critics say this has forced them to become more conservative, and less willing to pay outsize fees for external stockpickers, making the economics of funds management difficult.
“It’s been bloody tough – we make less money now with $20 billion in funds under management than we did at $10 billion or $15 billion,” Paradice said.
“We’ve seen some consolidation, which can be good because it gets rid of the bad money managers and the people who take shortcuts, but there will be more funds closing unless they can turn around their performance.”
Paradice said the annual performance tests – administered by the Australian Prudential Regulation Authority – had distorted equity markets as big super funds kept buying the largest stocks irrespective of valuation, wrong-footing active managers who were investing on fundamentals.
In a note on Wednesday, MST Marquee analyst Lafitani Sotiriou told clients that the performance test “inherently favours passive investing”.
“The super performance test is set up on a false premise that investment decisions and asset allocation can be homogenised. This is so far from reality, it is dangerous this hasn’t been nipped in the bud already,” he said. “As passive investment increases, healthy capital formation decreases.”
Only a quarter of active Australian large-cap equity managers outperformed the S&P/ASX 200 Index in the year to June 30, the weakest result in seven years, according to Morningstar. That accelerated an exodus from local funds, with investors pulling $6.6 billion in the last financial year and almost $22 billion in five years. At the same time, funds tracking Australian indices attracted a record $15.5 billion last year and $40.2 billion over five years.
The underperformance has also led to the shutdown of institutional equities funds including Platypus Asset Management’s and Tyndall Asset Management’s large cap strategies. More recently, Cooper Investors has flagged a significant downsizing. The eponymous firm has gone from managing about $14 billion to less than $2 billion in three years.
Rainmaker, a market intelligence firm, said that the average proportion of assets managed internally by super funds rose from 9.3 per cent in 2019 to 22.1 per cent last year. At AustralianSuper, internally managed assets grew from roughly 25 per cent to up to 37 per cent over the same period.
Sotiriou said the rise of passive management in super was worrying because they “do not hold companies to account like active funds”. The performance test had also led super funds to become a “passive free rider”, he added.
Paradice has bucked that trend, with all five of his Australian equity funds outperforming their benchmark on an annualised basis since inception.
He attributed the result to a number of factors, but said the most important was that he encouraged his portfolio managers to take on the market and “have a crack” – an attitude he said was fading across the industry.
The money manager pounced on beaten-down tech stocks like Xero and Seek earlier this year despite fears that artificial intelligence would disrupt their business models. The firm also stuck by its long-held view that major bank stocks are overvalued and primed for a correction.
Paradice has also benefited from its early investment in Firmus Technologies, a neocloud which is targeting a market capitalisation of $43.7 billion if it debuts on the ASX as expected at the end of the month.
“A lot of funds have their hands in their pockets and are just moving closer to the benchmark. And then you’ve also got growth managers who just keep buying irrespective of fundamentals, and they just backfill their models with assumptions so they’ve got a reason to buy a stock,” Paradice said, adding that retaining high-performing staff was also an important factor.
“You attract the right people by giving equity, so I’ve shared the equity. We have performance fees on all our products, and they share that as well.”
Paradice said strong performance numbers had caught the interest of offshore investors looking for exposure to funds that consistently outperformed their benchmark. While Australia accounts for about 2 per cent of global equity markets, foreign investors have been enticed by the sharemarket’s heavy weighting in resources stocks.
Paradice said there had been particular interest in the firm’s Equity Alpha Plus long-short fund, which had beaten the S&P/ASX 200 Total Return index by an annualised 6.7 per cent a year since inception in July 2019.
“Overseas, people are asking ‘how can we play this energy transition and AI boom conservatively without taking a lot of technology risk’,” he said.
“That’s why they’re coming to us because they can see the value we add, and they see Australia is a good place to invest because of the infrastructure and energy that is needed for the AI build-out.”