Capacity issues stifle managers

Investors are being told to consider how capacity issues affect active managers' ability to deliver added value in New Zealand equities.

Wednesday, September 23rd 2015, 6:00AM 1 Comment

by Susan Edmunds

The NZ Super Fund has released a new white paper explaining how it evaluates the capacity of active managers in the New Zealand share market.

It says fund managers with more assets under management are increasingly unable to implement their investment strategy and add value because the New Zealand equities market is small and relatively illiquid.

Capacity could be defined in three ways – the amount of AUM beyond which the strategy was no longer able to achieve its investment return objective, the amount that maximises total value-add and the amount that reduces alpha and total value-add to zero.

If the manager is invested in a particular equity and has more to sell than the market can readily absorb, the stock’s price will likely drop.

Conversely, if the manager wants to buy more than what is available, the price that must be paid will likely rise.

In either case, the manager’s ability to add value is compromised. Therefore, increasing AUM tends to result in lower returns, the Super Fund paper says.

NZ Super Fund head of asset allocation David Iverson said investors did not pay much attention to capacity constraints but it was important because active managers needed to be able to execute their best ideas quickly and at low cost, for their strategy to add value over the benchmark.

Sometimes bigger managers could have more capacity than niche operators, he said, because they would operate a strategy where turnover was lower.

That would offer more room to move than smaller managers holding bigger positions in smaller stocks.

"All investors need to think about this but I don't think they are mindful of it."

He said fund managers wanted to get as much AUM as they could because it would maximise their wealth but that did not necessarily maximise the wealth of their investors.

But investors would often follow other investors so more money flowing to one manager would be interpreted as meaning it was a good manager, and even more money would be invested there.

"But that may not be a good thing because the manager may be over capacity," Iverson said. "Capacity is not well understood."

The white paper said the Super Fund conducts a capacity analysis of each of its current and potential NZ equities managers to decide which it would use.

Tags: NZ Super Fund