23 April 2024

Stay behind for detention – active managers on the naughty step again

By Mark Christie, Financial Planning Director

What would you do if your child came home with the same poor report card from school, year after year? Most responsible parents would take action after the first one, and not let it become a perennial problem.

It’s a shame that the active fund management industry doesn’t take the same approach. Their collective annual report card has just been published and once again, performance goes well beyond the ‘could do better’ category, sitting comfortably in the ‘disinterested to abject’ range.

Once a year, global fund rating agency Standard & Poor’s (S&P) releases its annual look back at the performance of active managers against the indices they invest in. The report, called the SPIVA (which stands for S&P Index versus Active) Scorecard has now been produced for 10 consecutive years for funds marketed in Europe, and for more than 20 years for US funds, and the results have been consistently bad throughout the last two decades.

Now let’s be clear, the entire proposition of active fund management is that it should deliver market beating performance for investors due to the skill of the manager, i.e. being able to pick stocks and time markets better than the competition, and certainly better than simply buying and holding an index fund to receive the return from a particular market. These supposedly ‘skilled’ fund managers get paid a fortune to try to deliver market beating returns. But, once again, the overwhelming majority - a whopping 84% - of active global equity managers in Europe failed to beat a comparable index of global equities in 2023.

Widen that period to a more meaningful investment time horizon of 10 years, and 97.82% under-perform the index. Just let that sink in. That’s a success rate of 2.08%, i.e. 2 funds in 100 survived for 10 years and beat the index. Not only that, but to have benefitted from this ultra-rare outperformance, you would need to know in advance which 2 funds to back at the start of the 10 year period. In fact, there is no single year since the European SPIVA report was first published where the majority of active global equity managers have beaten their respective index.

One of the main reasons that active management fails to deliver for investors is the strong chance that your fund will not stand the test of time, and mainly due to poor performance, be closed or merged into another fund. Almost 56% of sterling denominated global equity funds were closed or merged in the last 10 years, so it’s a flip of a coin to know whether your fund will even make it to its 10th birthday!

The other main reason is cost. Active fund management is extremely expensive and there are lots of people with their snout in the trough needing to be fed before you, the end investor, get to keep what’s left of the returns. Myriad sector analysts carrying out in-depth research on companies and the aforementioned fund managers who go to meet the management teams of the companies they are considering investing in to decide where to allocate the proceeds from the sum you have invested. Although, quite obviously costly, this probably all sounds like sensible due diligence, so why doesn’t it work?

Well, the stock market is a huge information processing machine and all of the relevant information about every company is already in the public domain and freely available. Any news is instantly factored into prices via the trades between buyers and sellers. This is known as market efficiency. So, how can one fund manager, no matter how many analysts are assisting, know more than the collective wisdom of the entire market, made up of all buyers and sellers?

They can’t! Mispricing in individual securities can and does occur, i.e. the market doesn’t get it 100% correct every minute of every day, but the mispricing is random and by definition, unpredictable. Factor in the huge cost associated with active management, the lack of any information advantage for the most expensive fund management teams, and it starts to make sense why backing an investment strategy which relies on stock picking and market timing will end in failure.

The good news is that there is a much lower cost, more scientific way to invest and it’s how we’ve been allocating our clients money for 15 years.

If you want to know more, please get in touch and we’d be delighted to explain how its done.

Source: S&P SPIVA Europe Scorecard – Year End 2023

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This communication is for general information only and is not intended to be individual advice. It represents our understanding of law and HM Revenue & Customs practice. You are recommended to seek competent professional advice before taking any action.

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