In Focus: Megatrends  

Why I won't buy active funds despite the upheaval

Paul Gibson

Paul Gibson

In order to achieve the best possible outcome for clients we believe that globally diversified portfolios with low ongoing costs and low trading costs are most likely to deliver.

There is of course no such thing as the perfect portfolio. At Granite Financial Planning, a small financial planning business specialising in the retirement planning arena, we have adopted an evidence-based investment approach using passive index funds since inception.

All clients have a financial plan incorporating a lifetime cash flow model that helps inform all decision making, including building a suitable investment portfolio.

We were recently asked by an industry expert whether we have changed our investment approach to include active funds during the Ukraine crisis.

The answer is no. We are still using indexing and have not been tempted to move to active management despite all the recent upheaval we have experienced.

Markets were showing signs of volatility before Russia invaded Ukraine due to the Nasdaq falls and increasing global inflation rates. 

Active fund management simply does not deliver over the short, medium, or long term and consistently underperforms against the relevant index benchmarks. 

The latest S&P indices versus active (Spiva) scorecards for 2021 have again demonstrated that the majority of active funds underperform against their chosen benchmark.

Research from Morningstar reaches a similar conclusion, as demonstrated in their active/passive barometer report. 

There is no evidence active managers perform better in declining markets or when markets are more volatile. They are, however, consistent in their mediocrity.

Market volatility is a normal occurrence and indeed the S&P 500 average intra year decline from 1980 to 2021 has been 14 per cent.

Despite this volatility markets have delivered positive returns in 32 of the 42 years studied.

Market timing, while intellectually appealing, is impossible to implement consistently in real life as the decisions of not only when to exit the market but also when to re-enter the market need to be correct.

Trying to time the market runs the risk of missing the best performing days. The best and worst trading days often happen close together and occur irrespective of the overall market performance for the year. 

In times of market stress market-timing strategies have proven not to deliver as the inflexion points happen too unpredictably.

This is a view shared by well-known active fund managers Warren Buffett of Berkshire Hathaway and Terry Smith of Fundsmith. 

Peter Lynch, the legendary Fidelity fund manager, was famously quoted to say: “Far more money has been lost by investors preparing for market corrections than has been lost in corrections themselves.”

The costs of active fund management are the main drag on performance and although there may be some good fund managers operating, any excess returns are often not attained by the end investor but are retained by the fund management group.