For as long as I can remember, and especially since the RDR, the investment world has been embroiled in an ongoing ‘active versus passive’ debate. To be honest, I don’t really have a problem with “active” or “passive”; it’s the “versus” that rankles.
That word sets up a conflict, as if the entire industry is built on a black and white choice between two investment approaches, a Jets-and-Sharks-type battle where everyone has to pick a side and stick to it. Never the twain shall meet.
My instinct has always been to lean towards active. I wrote a comment piece once asking what was the point of passive investing? It seemed to me that, with any passive fund, the charges – however small – would always mean you were guaranteed to underperform the market you were tracking. You need outperformance to counter the charges; and the way to outperformance is active fund management. It amazed me that anyone could question – let alone disagree with – my watertight logic.
My convictions were endorsed by the disproportionate focus on active managers. The whole industry is built on a belief in various individuals’ ability to achieve outperformance. Admittedly we in the media are guilty of perpetuating this, but I suspect you would tire of reading about funds that do little more than track an index just as quickly as we would tire of writing about them.
The attention lavished on active managers is largely misplaced. There is a romantic notion, a mystique attached to the fund managers who consistently deliver. Sadly, I am slowly coming round to the understanding that the majority possess no more genius than the Wizard of Oz, finally revealed to be just a man, albeit one with a big shiny façade, a microphone and an amplifier.
Yann Martell’s novel, ‘Life of Pi’ works as an allegory for religious faith. The book claims very early on that it will tell a story to make you believe in God. It goes on to give the reader a choice between a mundane story, or a wildly imaginative, incredible recounting of the same, bleak events. Isn’t it better, more fulfilling, the book suggests, to believe in the fantastical?
I fear some of us have applied the same principle to fund management and now ascribe omnipotence to fund managers, irrespective of their actual abilities.
The simple fact is, for every ‘star’ manager, there are several who – simply – are not very good. But we seldom point out the emperors who aren’t wearing any clothes.
A reader wrote in last week to question the statistics at the back of the magazine.He highlighted one fund we list which has never troubled the top quartile over any time period we cover, has returned losses of almost 10 per cent over the past year against a sector average profit, and was ranked 239 out of 242 in its sector over five years. The qualitative rating? Gold.
I won’t name the actual company involved. The problem raised could be equally applicable to hundreds of funds from several fund houses, and the issue relates more to how we view these firms than anything they do themselves. Nor do I mean to suggest this glorification of active managers – even when they have demonstrably underperformed passive funds – is exclusive to the agency whose ratings we publish. It is endemic throughout our industry.
The fact is, fund managers are humans and will often get decisions wrong. Every time they decide to buy or sell, there is a good chance they would have been better off doing nothing.
I have heard an oft-repeated stat that a fund manager only has to get 51 per cent of 50:50 calls correct to be considered outstanding in his or her field. That means, even for the best, up to 49 per cent of the time their tinkering is costing investors money.
What’s worse is, while affording fund managers godlike status to justify the percentage point of performance fees they command, you are probably undervaluing your own contribution.
Research from Vanguard has attempted to quantify the difference between the returns an investor could achieve with, and without, professional advice. It estimated that a good adviser could add as much as 3 per cent value a year to each of their clients. This is achieved through a combination of rebalancing portfolios, asset allocation strategies etc, but over half of the uplift was credited to what the research termed ‘behavioural coaching’, but what I would call ‘bedside manner’ – a human touch helping clients to make difficult decisions.
Whatever the mechanics of the calculation, 3 per cent represents a level of outperformance many active managers can only dream of.
It occurs to me that, all the while we are lionising fund managers, we are largely ignoring those of you at the coalface, who cut through all the bluster and adulation to deliver a tangible benefit to investors.
Instead of focusing on active versus passive, maybe we should give a little more credit to those of you who manage to find a balance between the two and add actual value for your clients.