With active fund management in crisis, the financial media is teeming with suggestions as to how to rescue it. Indeed I’ve chipped in with some suggestions of my own.
Interestingly, a recurring theme coming from active managers is that they need to try harder. With alpha so hard to unearth, some have vowed to redouble their efforts to find it. “We’re determined to deliver value.” “We’re passionate about what we do.” “We’re working day and night looking for opportunities.” We hear it all the time.
I’ve never doubted that fund managers work hard or that they’re hugely conscientious. I don’t doubt either that most of them genuinely want to deliver value for end investors. The problem is that hard work isn’t the answer.
The former fund house executive Lord Myners has just written to the Financial Times about this very issue. His letter was in response to an article by Norma Cohen highlighting the damage caused to returns by the fictional cost of trading.
“The simplest way to see this effect,” he says, “is to ask your fund manager ‘how would the investment portfolio you manage for me have performed if you had done nothing during the measuring period, just sitting on the original portfolio?’”
“In my experience,” he goes on, “this analysis shows that well over 50% of fund managers of diversified equity funds produce lower returns than would have been achieved if they had gone on holiday for the full period.”
I haven’t seen any specific analysis that Lord Myners has conducted, but it’s certainly consistent with the academic research. Simply put, the more fund managers trade, the worse they do. Yes, that’s partly down to picking the wrong stocks and poor timing, but it’s mainly a function of the additional costs that frequent trading entails.
What Myners calls the Inertia Test of performance is more insightful in many ways than comparing returns with an index or benchmark, and yet fund managers don’t want to know about it. Nor, alas, do those other gate-keepers whose business models depend on the myth that the more actively you invest the better — researchers, brokers, consultants and, sadly, large sections of the financial media.
I’m not against active management at all. But it has to deliver value for the people paying for it — not just for those who work in it. Fund houses could dramatically improve net returns by simply cutting their wage bills. That means far fewer fund managers, working much shorter hours. And seriously, instead of paying them superstar salaries, why not just give them very long holidays?
This article was originally published on the website of RockWealth, an evidence-based financial planning firm in Cheltenham.
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