In recent months, the performance of the Long Term Growth Fund (LTGF), the flagship multi-asset fund within the suite of TCorp IM funds available to NSW government related entities, has deviated significantly from its objective, at least on a short term basis. For the 2022 Financial Year, the fund performance was a -7.88% absolute return against an objective of achieving a positive return of CPI+3.5%. This was an under-performance of 17.5% using the headline measure for CPI.
Performance was poor for a couple of reasons. Firstly, the LTGF is exposed to growth and other volatile asset classes that seek to make higher returns over the longer term, but with the risk of short-term volatility or negative returns (FY22 was one of those periods of negative returns!). Secondly, the objective is not the same as a benchmark, and the asset classes in which the LTGF invests are perversely mildly inversely correlated to inflation[1] i.e. when inflation rises the value of the assets in which the LTGF invests tend to fall and vice versa making performance against objective even more volatile than absolute performance!
TCorp strongly argues that investors need to take a long term view when investing in growth assets and should ideally take a 10 year view with the LTGF. As per the graph below, the LTGF has had an excellent performance historically when measured on a 10 year horizon.
In simple terms, the chart above shows for any 10 year period (not including the two years of the financial crisis being 2008 and 2009) the LTGF has exceeded its objective. Further it exceeded its objective in three of the nine years including the 2008 and 2009 period and even its poorest performance (the 10 years to 2010) was above an average annual return of CPI+1.5%[2].
Based on this analysis, it appears the LTGF has performed extremely well on a historical basis even including the very poor FY22 result (which was the second worst one year performance against benchmark in its history being better than FY08 and poorer than FY09). However 10 years is a much longer time horizon than most investors are seeking (few finance managers want to explain to those higher up in their organisations and their communities it may take another nine years to recover from a single bad investment year).
Perhaps a better graph to explain the risks is the five year rolling performance as shown below. This reveals the poor performance in FY22 essentially wiped out the good performance of the previous four years, leading to a slight under-performance against objective over the five year period.
Perhaps the more illustrative example of a plausible worst case scenario is that once the good performance in 2007 was replaced in the rolling five year returns, the LTGF under-performed its objective by -7.0% in 2012, which meant it had a negative five year return on an absolute basis of -0.3% whilst CPI increased by an average 3.2% over the period, leaving performance a cumulative 19% behind CPI over the period and even further behind the alternative of investing in Term Deposits or Bank FRNs.
On the flip side of the 29 five-year periods since its inception in 1989, the LTGF has only under-performed CPI in the periods ending 2011 and 2012 and its average performance has been to exceed its objective by 1.9% for an average return of CPI+5.4% (a performance way in excess of investing in Term Deposits and FRNs).
Overall Amicus conclusion is the LTGF should provide superior returns to alternative investments in Fixed Income products if historical performance is replicated in the future (and obviously there is no guarantee this will be the case). However, periods of under-performance are likely and it may take many years to recover from one or two years of negative returns.
Amicus has generally supported its NSW council clients in investing in the LTGF to gain exposure to growth assets with a view to mitigating long-term liabilities to which councils are exposed. However it has also recommended strategies to reduce the volatility of returns both within the investment itself and the overall portfolio. Collectively, Amicus clients have a positive mark to market on their LTGF exposures measured from inception to the end of October 2022 despite many of them initiating investment in FY22.
[1] Plotting the one year LTGF returns against inflation shows very little relationship, but a best fit line shows a negative relationship as would be expected on a fundamental basis which very simplistically argues high inflation is bad for the economy and therefore bad for both debt, credit, property and equity investments.
[2] The worst performance in the 10 years to 2010 is -1.8% and the fund’s objective is CPI+3.5% so the LTGF exceeded CPI+1.5% in all rolling 10 year periods.
