How to Win the Loser's Game, Part 3
http://www.sensibleinvesting.tv/
Part 3 of this documentary on evidence-based investing looks at the dismal performance record of actively managed funds.
Presented by Robin Powell, it includes contributions from Michael Johnson from the Centre for Policy Studies, Vanguard founder Jack Bogle, the former fund manager Alan Miller and Daniel Godfrey from the Investment Management association.
Transcript:
Of course, the fund management companies could justify high fees and making large profits if they added significant value. Unfortunately, the performance of actively managed funds is consistently very poor.
Fund managers aim to maximise investment returns. Over time, markets deliver returns on their own. They’re what we call the market return. We pay managers to deliver more than the market return. In fact, after costs, they rarely do. One well-known sceptic of fund management famously described it as an industry built on witchcraft.
Jack Bogle says: ““The intellectual basis for indexing is (as I’ve said), is gross return minus cost equals net return. Period. What is the intellectual basis for active management? I’ve never heard one. Probably about 1% of managers can beat the market over the very long term.”
That figure of 1%, you may recall, is consistent with the findings of the Pensions Institute report. And that study found that even those 1% of managers kept for themselves the value of any outperformance in fees. Several other studies have reached a similar conclusion.
This is an independent report commissioned by the UK Government into the Local Government Pension Scheme - one of the biggest public pension schemes in Europe.
As you would expect, some active managers used by the LGPS have outperformed. But the report found “there is no evidence that, in aggregate, the Scheme has outperformed regional equity markets”.
In fact, in many cases active funds were trounced by passive ones. For example, over ten years, passive North American equity funds delivered average returns of 2.6%, as opposed to 1.7% delivered by active funds. Passive Japanese equity funds recorded average returns of 2.6%, compared to 2.0% for active. What’s more, these returns do not not take into account the impact of investment charges.
The report found that in 2012, asset management costs for the scheme amounted to £790m - the vast majority of which was paid to active managers. Switching from active to passive investing would save the tax payer a staggering £660 million a year - and deliver similar, if not better, performance.
Michael Johnson is a public policy adviser with a specialist interest in pensions. He says the LGPS report is a wake-up call for the whole investment industry.
Michael Johnson says: “Very few people enter that industry with the express purpose of enriching others, and they’re good at what they do, which is enriching themselves.”
Alan Miller was a successful fund manager. But over the years he became disillusioned with the industry, and particularly with the poor performance that managers were delivering year after year.
Alan Miller says: “The marketing budgets within the big retail companies are millions and millions of pounds, and they’ve created this image whereby the customer thinks that these big brands are nice and safe, nice and solid, and they think they’re getting something better. They’re actually getting something worse. The bigger the institution, the bigger the brand, normally the more you pay and normally the worse the performance.”
Michael Johnson says: “In a nutshell you have an industry of fund managers who are trying to out-compete one another in a giant negative-sum-game. They are extracting charges and fees on an annual basis which erode the capital of savers. It is nigh impossible to work out who is going to outperform the rest on a consistent basis.
"This is an industry that is a genius at obfuscation and bamboozlement, with terminology that is utterly meaningless. And it needs to be challenged.”
So, what are the implications of all this for the investor? Well, the system needs active managers to set prices - to ensure we all receive value for value for money. But that doesn’t mean every investor has to pay for their services.
Indeed, the high cost of active management combined with its dismal track record - and the near impossibility of identifying the next star performer - should make the average investor extremely wary.
But, before investigating alternative approaches, we’re going to find out what the academic evidence says about investing - and how best to go about it.
http://www.sensibleinvesting.tv/
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