Author Topic: Australian Investments - Active or Passive for Small Cap Funds?  (Read 1870 times)

Dropbear

  • 5 O'Clock Shadow
  • *
  • Posts: 69
Australian Investments - Active or Passive for Small Cap Funds?
« on: September 15, 2016, 07:54:09 AM »
G'day,

It's great to see a bunch of like-minded Aussies in these discussions, so I thought I'd introduce myself here.  I'm a newly-minted mustachian from Sydney who is quite happy to saving.  I prefer doing stuff rather than having stuff!

I'm 32, and having made some spreadsheets, I predict I'll need around 8-10 years to FIRE.  I have $50k to invest now (should have started this earlier), and being youngish, I'm thinking of broadly splitting my investments between 30% higher risk to 70% growth/balanced risk.  I'm certain that I would like to invest indirectly, as I don't have the nous nor time to be an direct trader.

My question is about active verses passive options for small-to-mid cap investments?  I've read in various places that for most types of investments, passive funds like ETFs are often quite competitive with active funds because the higher fees of active funds often balance out with index performance...  except in the small cap bracket, where active funds often outperform indexes.

An example of this suggestion: http://moneymag.com.au/fund-managers-get-poor-report/

My plan is to allocate the 70% towards a range of Australian and International ETFs.

I'm trying to decide between allocating my 30% to either:
A - An active and more expensive managed fund
B - A passive and cheap small cap ETF.

I don't yet know much about LICs, and if or where these might fit into this picture.

Has anyone else considered mixing (or not mixing) active and passive investments?  If so, what did you decide to do, and why?

Thanks!

Dropbear
« Last Edit: September 15, 2016, 08:00:55 AM by Dropbear »

steveo

  • Handlebar Stache
  • *****
  • Posts: 1944
Re: Australian Investments - Active or Passive for Small Cap Funds?
« Reply #1 on: September 16, 2016, 01:52:02 AM »
It's up to you. Personally I think you will be better off picking one investment fund or idea and sticking to that.

I think you should figure out stocks/bonds/cash ratio's and then within the stock portfolio how much Aussie and how much all world. Then I would invest basically just in Vanguard funds.

Basically pick your asset allocation and then pick the cheapest broadest index funds you can get.

Anatidae V

  • Walrus Stache
  • *******
  • Posts: 8604
  • Age: 30
  • Location: Fourecks
  • Nullus Anxietas
Re: Australian Investments - Active or Passive for Small Cap Funds?
« Reply #2 on: September 16, 2016, 04:50:22 AM »
I am still dipping my toes into the shallow end, but I plan on sticking with passive management. I don't think I'll even have small caps, just overall Aus market, international market and some high yield Australian (because dividends make sense to me, not for any more realistic reason).

As to why - simplicity. I need to not think about it at all, and I feel like if I go with an actively managed fund I have to research them and the current fund managers.

superannuationfreak

  • Stubble
  • **
  • Posts: 124
  • Location: Melbourne, Australia
Re: Australian Investments - Active or Passive for Small Cap Funds?
« Reply #3 on: September 16, 2016, 07:35:04 PM »
It is a conundrum.  Active management fees are too high, an manager research too hit-and-miss for most of us, while passive small cap contains too many unprofitable companies and tends to perform poorly.

What I've chosen to do is have any higher-cost/less tax efficient assets in Superannuation.  In my case this is partly because I work for a super fund and should keep some assets with them to make sure my interests are aligned with members.  But I've realised it makes sense from an efficiency point of view: many Industry Super funds have a strong track record with Australian managers, particularly in small caps, and an even stronger track record negotiating down costs with Australian managers.  Also Australian small caps tends not to be very tax efficient so I'd rather not hold much outside Super.

The other thing I've done is allocate more to International than I would do if all costs were equal.

What approaches would I consider if I wanted a chunk of higher-risk/higher return potential assets and wasn't in my current work situation?
If I wanted to keep things simple I'd have some of my super in a lower-end-of-the-cost-spectrum growth or high growth industry super fund (noting that I'd still be paying 0.5%-1% p.a. for this).
If I were willing to choose asset classes but didn't expect to have particular stock or active manager selection skills (and I don't) then I'd probably stick to a broad ETF or index fund for my international exposure and use an industry fund for my Australian equities and fixed income.  For example, Australian Super (I don't work for them, nor endorse them, just using them as a well-known low cost example) will charge about 0.3% p.a. for Australian shares which will include a decent slice of small caps.

If I felt I had to hold Aus Small Caps outside super (I've decided I don't) then I would probably look at Realindex Australian Small Companies Fund - Class A (0.66% p.a., $25k minimum) or VanEck Vectors Small Cap Dividend Payers ETF (MVS - 0.49% p.a.).  The latter now has over $40m in assets so closure risk is a bit lower than it was when it started, and the dividend focus tends to weed out the least profitable companies.  Both of these still charge more than I'm willing to pay for not-quite-the-exposure-I-want but they're getting closer to the mark.

Dropbear

  • 5 O'Clock Shadow
  • *
  • Posts: 69
Re: Australian Investments - Active or Passive for Small Cap Funds?
« Reply #4 on: September 16, 2016, 08:09:41 PM »
Thanks Steve and Anatidae for your comments.

Broad index funds (like Vanguard's VAS and VGS for example) will certainly make up the the majority of my investment, and definitely in an appropriately diverse mix.

I'm also interested in the idea of allocating a smaller proportion to funds with more growth potential than the established market leaders.

A small company index fund (like VSO for example) is one alternative for investing in small-caps.  However, according to the SPIVA Australia Scorecard (https://au.spindices.com/documents/spiva/spiva-australia-year-end-2015.pdf), the majority of small-cap managed funds have beaten this index.  Essentially I'm trying follow along on this small-cap category performance statistic, but it's hard to tell if a supposedly higher returning managed fund in this category will justify its higher fees for a mustache-wearing investor?

Dropbear

  • 5 O'Clock Shadow
  • *
  • Posts: 69
Re: Australian Investments - Active or Passive for Small Cap Funds?
« Reply #5 on: September 16, 2016, 08:47:06 PM »
What I've chosen to do is have any higher-cost/less tax efficient assets in Superannuation.

Very interesting, thanks superfreak!  I need to do some research to property review my super (which isn't so healthy right now), and work if or how I might strategically focus investments in and out of super.

Also Australian small caps tends not to be very tax efficient so I'd rather not hold much outside Super.

Can you please clarify this for me?  Am I right in thinking it's because: if you have greater interest earnings and/or capital gains from higher performing (ie small cap) investments, then you pay a higher tax on these if they are outside super relative to inside super?  Or am I on the wrong track?

If I felt I had to hold Aus Small Caps outside super...

Thanks for those fund suggestions, and I agree with your concern about fees verses ability to passively target the investments you want.  The VanEck Vectors S&P/ASX MidCap ETF also looked close-but-not-quite like what I was looking for, and with similar fees to the Small Dividend Payers ETF.  It's also interesting that you suggest the dividend payment is almost a screen for good performing small caps.

I have been looking at Ausbil and UBS small cap managed funds more specifically so far, and it'll be important to compare these with your ideas to get a better impression of how each stacks up.  Cheers!

superannuationfreak

  • Stubble
  • **
  • Posts: 124
  • Location: Melbourne, Australia
Re: Australian Investments - Active or Passive for Small Cap Funds?
« Reply #6 on: September 16, 2016, 11:31:50 PM »

Also Australian small caps tends not to be very tax efficient so I'd rather not hold much outside Super.

Can you please clarify this for me?  Am I right in thinking it's because: if you have greater interest earnings and/or capital gains from higher performing (ie small cap) investments, then you pay a higher tax on these if they are outside super relative to inside super?  Or am I on the wrong track?


Not quite what I meant.

In the case of a completely indexed Small Companies fund, the best outcome is for companies to leave the fund by becoming too large (i.e. their price goes up a lot).  When they, for example, become large enough to enter the ASX100 a Small Ordinaries index tracking fund will sell them and realise capital gains on the sale.  These capital gains will be distributed to you and hence taxed (hopefully at concessional rates), where in an ASX300 fund a stock would be more likely to be held onto so more capital gains taxes can be deferred until you choose to sell the fund/ETF yourself.  This deferral of taxes gives your money longer to compound (and if you are planning to retire, means you can avoid incurring the capital gains until your taxable income is lower in retirement).

For active small cap funds it can be even worse, as these funds will usually have higher turnover than the index.

Dropbear

  • 5 O'Clock Shadow
  • *
  • Posts: 69
Re: Australian Investments - Active or Passive for Small Cap Funds?
« Reply #7 on: September 17, 2016, 06:42:38 PM »
...These capital gains will be distributed to you and hence taxed (hopefully at concessional rates), where in an ASX300 fund a stock would be more likely to be held onto so more capital gains taxes can be deferred until you choose to sell the fund/ETF yourself.  This deferral of taxes gives your money longer to compound (and if you are planning to retire, means you can avoid incurring the capital gains until your taxable income is lower in retirement).

For active small cap funds it can be even worse, as these funds will usually have higher turnover than the index.

Thanks for the explanation, superfreak!

Are taxes always incurred at the time when a fund (active or passive) distributes its income, or does choosing a reinvestment option defer the taxes until a later date?

superannuationfreak

  • Stubble
  • **
  • Posts: 124
  • Location: Melbourne, Australia
Re: Australian Investments - Active or Passive for Small Cap Funds?
« Reply #8 on: September 17, 2016, 07:54:36 PM »
Are taxes always incurred at the time when a fund (active or passive) distributes its income, or does choosing a reinvestment option defer the taxes until a later date?

Taxes are incurred for the year the income is earned/distributed, dividend reinvestment still requires us to pay the relevant tax on the dividend/distribution.

Dropbear

  • 5 O'Clock Shadow
  • *
  • Posts: 69
Re: Australian Investments - Active or Passive for Small Cap Funds?
« Reply #9 on: September 18, 2016, 03:58:53 AM »
Taxes are incurred for the year the income is earned/distributed, dividend reinvestment still requires us to pay the relevant tax on the dividend/distribution.

Ok, cheers for answering what seems to be fairly basic questions!  So could these investment type and tax concepts be summarised by saying generally that growth-focused investments are fine outside super, but yeild-focused investments are better inside super?  Unless the yeild happens to be franked, in which case franked dividend yields are attractive outside super?

I'm planning for VAS to be one of the main carriages on my FI train, and was contemplating adding a little VHY pre-FIRE.  I was previously thinking that VHY would perform better as post-FIRE income, but now I'm wondering if it can also assist pre-FIRE growth by off-setting other gains made each year?