Active strategies are still hugely popular amongst investors. Despite their popularity though, the evidence shows that very few of these actively managed funds actually manage to outperform the market average. Robin Powell talked to the University of Bristol's PROFESSOR IAN TONKS to find out why.
TRANSCRIPT
Robin Powell: Most investors use what’s called an active fund manager. Now, that manager actively picks stocks to try to beat the market. But the evidence shows that, over the long run, very few funds actually do beat the market. One such study analysed the performance of around 500 UK funds over a period of 15 years.
Ian Tonks: We have some relatively sophisticated benchmarks to try and identify this outperformance. What we find is that, typically, again about one per cent of these active fund managers do systematically outperform their benchmarks - but again, only in terms of their gross returns. It’s almost whatever benchmark you put up against these returns, in terms of net returns, no fund manager outperforms.
RP: In other words, if it weren’t for fees and charges, some active funds would beat the market. But the costs simply outweigh the benefits. So why do active managers find it so hard to outperform? Well, for Professor Tonks, it’s primarily down to the fact that they’re caught between the need to pick winners on the one hand, and the need to reduce risk on the other.
IT: That kind of trade-off between spreading the risk and also trying to spot winners and losers actually means that, often, the fund manager is constrained such that - even if they do spot the winners - they have not invested sufficiently in those winners to really generate any substantial outperformance.
RP: The findings of Professor Tonks and his colleagues are consistent with those of many other studies of active fund performance around the world. So, I asked him, did his research inform his own personal investment strategy?
IT: So the answer’s yes. I invest in a number of different passive funds, I take a strategic asset allocation view, I decide whether to invest in investment overseas or in the UK, and what kind of funds do I want to invest in the UK, and then my savings are essentially in passive tracker vehicles.
RP: In summary then, it’s possible - in theory - that, if you invest in an actively-managed fund, you’ll outperform the market on a cost- and risk-adjusted basis in the long run, but it’s unlikely. Effectively, it’s a bet — and a bet you’re likely to lose.
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