“The suit of clothes is altogether, but altogether
The most remarkable suit of clothes that I have ever seen.”
As a child I loved The Emperor’s New Clothes by Hans Christian Andersen, the tale of a vain ruler who hires two dishonest weavers to make him the finest outfit. The weavers convince him that they’ve “made” the suit out of a magic fabric that is invisible to anyone who is unfit for his position or “hopelessly stupid”.
Although his ministers can see the clothes really are invisible, they pretend they’re not for fear of appearing unfit for their positions, and the Emperor does the same. Eventually, the weavers pretend to dress the Emperor, who proudly parades in his new suit before his subjects.
Because they don’t want to appear stupid either, the townsfolk also play along with the pretence. Suddenly, a child in the crowd, too young to understand these adult mind games, blurts out that the Emperor is wearing nothing at all and everyone falls about laughing.
What a perfect analogy this tale is for the asset management industry. The Emperor is the investor; the weavers are the fund managers; and the ministers are the great and the good of the investing world — the experts and the commentators.
Sadly, all too many investors are as gullible as the Emperor. They want the best portfolio and when someone offers to build it for them, they’re happy to take their word for it. The “weavers” know how easily taken in investors are, and they particularly like to design the most sophisticated and expensive products for those with deep enough pockets. The “ministers” only serve to compound the Emperor’s embarrassment; instead of alerting investors to the con, it serves their interests better to go along with the whole charade.
There’s a welter of evidence dating back more than half a century which shows that the vast majority of products the investing industry sells us are, frankly, a waste of time and money. Of course the marketing and advertising used to sell them implies they’re just what we need. But, time and again, the data tells us that, net of costs, these overpriced and overrated products end up extracting more value then they add.
A useful source of evidence is SPIVA — the Index Versus Active data provided by S&P Dow Jones Indices. It compares the performance of actively managed funds with the appropriate benchmark. Unlike the data the industry prefers to use, it takes into account the cost of investing and survivorship bias. No, it’s not perfect. Most active funds, for example, include securities from different indexes, making direct comparison impossible. But it does give a reliable picture of how, in general, active funds perform.
The latest SPIVA data for US-domiciled funds has just been released, and once again the picture isn’t pretty for the active fund industry. By law of averages, you would expect at least half of all active active funds, before costs, to beat the index. But in 2015, for example, 66.1% of large-cap managers, 56.8% of mid-cap managers, 72.2% of small-cap manager underperformed their respective benchmarks.
Of course, no one should be investing for 12 months. But, the longer the time period, the harder it becomes for an active manager to deliver the market-beating returns they’re supposed to provide.
Over the five-year period ending on December 31st, 2015, 84.2% of large-cap managers, 76.7% of mid-cap managers and 90.1% of small-cap managers failed to beat the benchmark. Over a ten-year period, on an equal-weighted basis, actively managed large-cap funds underperformed their benchmark by 0.9%, mid-cap funds by 1.4%, and small-cap funds by 1.8%.
To be honest, I’m running out of things to say about these SPIVA reports. Author Larry Swedroe summed up the latest data by quoting Yogi Berra’s famous observation that “it’s déjà vu all over again”.
But we really can’t keep on saying this. Year after year investors are being made to look stupid. Yes, some are starting to realise that they’ve been swindled and are switching to low-cost index funds instead, but most remain in blissful ignorance.
It’s time for the Emperor to salvage some pride, return to the palace and put some proper clothes on. As for his ministers and those devious weavers, Off with their heads!
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