29 Nov Why Does a Consistent 1% Outperformance Matter?

Why Does a Consistent 1% Outperformance Matter?

At first glance, earning 1% more than the market benchmark might not seem significant. But thanks to compounding, even small gains can add up to a big difference over time.

What is Alpha, and Why Does It Matter?

Alpha is the extra return an investment earns above its benchmark, such as a share market index. Active fund managers aim to achieve alpha by spotting opportunities in the market. However, it’s not easy. Many factors can disrupt expectations, and not all managers outperform every year. Still, alpha is the measure of success for active managers, so they continuously strive for consistent results.

On the other hand, passive investments, like index funds or ETFs, aim only to match the benchmark’s performance. They are usually low-cost but won’t deliver returns beyond the index.

This creates a challenge for investors: should you aim for the potential of higher returns with active investments or stick with the simplicity and cost-effectiveness of passive ones?

Blending Active and Passive Approaches

A common strategy is to combine both:

• Core Portfolio: Invest in low-cost, passive funds to track the market.
• Satellite Portfolio: Add active funds to try for higher returns.

What is Systematic Investing?

Systematic (or quantitative) investing uses data, finance principles, and behavioural science to make decisions. Instead of relying solely on human judgment, it uses models to analyse data and identify opportunities. This approach has been popular with institutions for years and is now accessible to individual investors.

Systematic investing can:

• Deliver consistent results across different market conditions.
• Help avoid risks tied to human biases or single fund managers’ preferences.
• Provide stability and the potential for long-term outperformance.

With the core being the majority of the portfolio, achieving 1% alpha p.a. over index returns has a meaningful compounding wealth effect for clients over the long term.

Past performance information above is to illustrate the effects of compounding only and is not a reliable indicator of past or future performance of any fund. Future results are impossible to predict. 

Source: ASX300 Accumulation Index (Index). Index fund returns above represent the return of the Index minus 0.04% management fee which is indicative of the lowest fee passive ETF available in Australia as at 25/09/2024. Index return +1% return above assumes Index return net of 0.03% management fee and a 20% performance fee.

“On the surface, 1% alpha may not seem like much. However, when that alpha is consistent and compounds over long periods, things become interesting”

The Power of Compounding

Small gains can grow significantly over time. For example:

• If you invested $100,000 in a passive fund tracking the ASX 300 index 10 years ago, your investment would grow to $213,290 (after fees).
• If you invested the same amount in a fund earning 1% alpha annually, your investment would grow to $229,900—an extra $16,610.

Over longer periods, compounding magnifies the difference, creating significant wealth growth.

Risks to Keep in Mind

While these strategies have strong potential, investing always carries risks, such as:

• Market risk: Stock markets can be volatile, which may impact performance.
• Manager risk: There’s no guarantee the strategy will meet its goals.
• Investment risk: Returns can vary, and you may lose money in the short or long term.

It’s important to consider your risk tolerance and investment goals before committing.

The Takeaway

Consistently achieving even a modest 1% alpha can make a significant difference over time, thanks to the power of compounding. With the rise of systematic active ETFs, investors now have the tools to seek reliable returns while balancing cost and risk. Over the long term, patience and consistency often lead to rewarding outcomes.

This article was originally produced by Macquarie. You can read the full article here.

Important information and disclaimer

The information provided in this document is general information only and does not constitute personal advice. It has been prepared without taking into account any of your individual objectives, financial solutions or needs. Before acting on this information you should consider its appropriateness, having regard to your own objectives, financial situation and needs. You should read the relevant Product Disclosure Statements and seek personal advice from a qualified financial adviser. From time to time we may send you informative updates and details of the range of services we can provide.

FinPeak Advisers ABN 20 412 206 738 is a Corporate Authorised Representative No. 1249766 of Spark Advisers Australia Pty Ltd ABN 34 122 486 935 AFSL No. 458254 (a subsidiary of Spark FG ABN 15 621 553 786)