/ ACTIVES VS PASSIVES / provide powerful evidence the vast majority of fund managers in our dataset were not simply unlucky , they were genuinely unskilled .”
Some people say : “ That doesn ’ t worry me because I can identify star managers with genuine skill .” In reality it ’ s almost impossible to identify future winners in advance .
Blake and his colleagues calculated it takes “ eight years of performance data for a test of a fund manager ’ s skill to have 50 per cent power and 22 years of data for the test to have 90 per cent power ”.
Even if the managers you choose go on to be stars , there may be no advantage in using them . The study said : “ Though a small group of managers appear to have sufficient skills to generate superior gross performance , they extract the whole of this via fees , leaving nothing for investors .”
Of course , a small number of actively managed funds outperform with some consistency . But is this really due to skill ?
You can ’ t blame fund managers for taking the credit for outperformance . It ’ s natural , as well , that most financial advisers ascribe strong returns to managers ’ expertise . After all , their business model is based on their ability to pick the best funds . Journalists too are predisposed to emphasise skill ; star managers make great copy , quite apart from the advertising
The record of UK active managers is poor . The survivorship rate is particularly shocking
revenue that they generate .
In reality , though , much of what passes as skill in fund management actually isn ’ t . With around 200,000 active managers in the world , you ’ d expect there to be winners by the law of averages . In fact , rather fewer funds outperform consistently than you ’ d expect by chance . Luck undoubtedly plays a part in outperformance , though precisely how much is difficult to calculate .
But there is another explanation for outperformance that ’ s often overlooked : many managers who have beaten the market over the long term have done so by tilting their fund towards risk factors known to deliver higher returns .
As Eugene Fama and Kenneth French demonstrated in 1992 , small cap and value stocks have historically outperformed large and growth stocks , albeit with greater volatility . So , by increasing their exposure to small cap and value , managers can deliver higher returns over time in exchange for a bumpier ride along the way .
In the UK , for example , the average five-year returns of active managers are slightly better than their peers ’ in the US , France and Germany . This is because the FTSE 100 is dominated by a few large stocks , so UK managers naturally tilt towards smaller companies .
Of course , active managers are entitled to move up or down the cap scale , or invest in other asset classes ; typically the small print allows them to invest up to 30 per cent of the fund in something completely different . But a large cap fund with a 25 per cent holding in small and mid caps should not be compared against a large cap index .
Of course , none of this means there are no skilled managers . There are , but they ’ re low in number , almost impossible to identify in advance and , even if you pick one before they outperform , their fees are likely to cancel out much of any value they add .
The easiest , cheapest and most efficient way to invest is via a diversified portfolio of index funds . This should include tilting towards the different factors proved to generate higher returns . That ’ s nothing to do with skill ; it ’ s just evidence-based investing . •
Robin Powell blogs as The Evidence- Based Investor
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companies , emerging markets , technology and healthcare , where expert knowledge is imperative to help seek out value .”
He finished by pointing out that it is worth keeping an eye on some of the older passive funds as these can charge almost as much as their active rivals .
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In a recent article on FE Trustnet , Yves Choueifaty , president and founder of TOBAM , described many of the arguments in favour of passives as “ toxic ” and even said the death of active management would spell the end of capitalism .
“ Active managers are here to arbitrate what is
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expensive versus what is cheap and contribute to the reality of prices . If nobody is doing that , prices will mean less and less . Then you will have bubbles that will last longer before ultimately bursting ,” he explained .
“ It ’ s important to have active managers to make pricing efficient
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and so that the economy prospers . It ’ s important to understand that in order for the economy to prosper , we need a reality of prices and this is the role of active managers – to make sure markets are still efficient .”
Click here to read the full article .
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