OPINION | As highlighted in the 2016 Productivity Commission report into competitiveness and efficiency in superannuation, the industry needs to work harder to deliver the best possible outcomes to fund members.

In recent years, intense competition has indeed led to greater efficiency and lower costs in the asset management industry of Australia. As we in the industry are well aware, investing outcomes are readily quantifiable and relatively transparent.

Investors like to know if fund returns are ultimately driven by market exposure or the value-add (alpha) generated by active management. Many investors, unconvinced that active managers have the ability to generate consistent alpha, have started shifting money towards passively managed products in order to save costs. According to Rainmaker data, indexed assets now account for 18 per cent of the total market, up from 11.7 per cent some 10 years ago.

But investors should not abandon hope on all active managers in favour of passive ones. With interest rates normalising and growing return divergences in global financial markets, active managers are going to have significant opportunities to add value.

Investing is cyclical and achieving investment success requires skill. Active management, particularly value investing, has come through a difficult period. But there are indications to suggest that the worst is behind the value managers as markets have started to re-orientate towards fundamentals in recent times.

There has been much talk of the property boom and the low interest rate environment. Through the period of the past 20 years, the largest sector of the market, the financial sector, has produced stable and consistent earnings. As we return to a more normalised interest rate environment, challenges on lending practices and concerns over bad debts arise. The unwinding of the influence of low interest rates creates opportunities for individual stock selectors to discover bargains across the market and provides fertile ground for active management.

The case for active managers

Active managers still have a demonstrable record of success, notwithstanding some short-term challenges. According to the 2015-16 Mercer Investment Sector Surveys, the median long-only Australian equity manager has, on average, outperformed the ASX 300 Index by 70 basis points over three- and five-year time horizons.

Furthermore, the increasing pressure to ensure that every possible basis point of return is delivered to investors should benefit active managers, who efficiently manage after-tax outcomes. Adding value from due recognition of the value of franking credits and selective buybacks is only possible with active management. The Towers Watson report, “After-Tax Investing in Australian Shares” (January 2011) showed that an active manager delivering gross alpha of 1.5 per cent a year is able to add over 20 basis points annually for superannuation investors by tilting portfolios concurrently to higher dividends and a greater utilisation of franking credits.

In fixed income portfolios, the case for active management is even stronger. Many bond benchmarks, being issuance dependent, are dominated by some of the largest debt issuers. They include nations with the largest deficits whose central banks are undertaking significant asset purchase programs, resulting in significant distortions in bond markets and greater opportunities for active managers.

Falling interest rates over the past several years had provided a tailwind for bond indices. But when the interest rate cycle turns around, returns from bond indices will inevitably turn negative. Prudent active managers, however, will be able to reduce the interest rate exposure and mitigate this risk as compared to a passive approach that is locked into the interest rate cycle.

To summarise, we believe the unusual period of low interest rates has fostered a number of market distortions, resulting in a situation that favours passive investment. In an actively-managed fund, however, portfolio managers can add value by overweighting or underweighting particular companies or industries and positioning the portfolio based on their current views of economic conditions and the path of interest rates.

Whether to reduce volatility or to seek outperformance, the use of active management is an important component of achieving long-term returns and managing investment risk.

Maria Wilton is the managing director of Franklin Templeton Investments Australia.