Were you satisfied with your active manager in 2021? For British investors in the US stock market, where actively managed funds holding the biggest US stocks returned 27.5%, the answer may be yes. Also for Europe, large-cap funds posted gains of 14.9%, according to Morningstar data.
But look closer and active managers seem less prescient. Passive funds that track the respective US and European indices gained more after fees – 29.3% and 16.3%, respectively. After costs, 82% of large cap mutual funds in the United States and 86% of those of Europe have underperformed their benchmarks over the decade to 2020, according to S&P Dow Jones.
But that’s not why I will never buy an active fund again.
In the early 2000s, I was a reporter for a Hong Kong-based financial trade magazine. One of my jobs was to survey the world’s leading investment managers every few months to report what they were buying and why. Each time – without fail – they disagreed.
It didn’t matter what they were buying – developed stocks, emerging stocks, government bonds, high yield debt. Make your choice. Their views, without fail, were everywhere.
Often, they drew opposite conclusions from the same information. Perhaps there was a consensus that US interest rates needed to rise. For one manager, that meant selling her US bonds. For another, it meant buying more.
I didn’t claim to be an expert, but I had always assumed that there was a good investment decision: the better informed you were, the more likely you were to make it. I was increasingly troubled that the highest paid investment managers in the world, backed by an army of analysts analyzing every bit of data available, would time and again make divergent choices.
Managers argued that their superior judgment made the best sense of the data. But I started to doubt there was such a skill when it came to picking stocks. Even if there was, I was now sure I couldn’t spot it.
So, with my Isa investments and then my retirement, I opted for passive investing. I chose a low-fee exchange-traded fund (ETF) based on the US S&P 500. The index might only include the largest US companies, but a considerable portion of their revenue comes from overseas; it was a decent share of global growth, I thought. After an unfortunate flirtation with so-called “smart beta” passive-style funds, I realized I was overwhelmed and moved to a simpler market-cap-weighted version.
I have done well so far — the index is up about 120% since the start of 2016 when I made my first pension contribution. Despite the economic devastation caused by the pandemic and the war in Ukraine, the index is up 85% since its low in March 2020. I doubt the next six years will be so rosy. With interest rates set to rise and rumors of a recession in the US, I am also prepared to take losses.
Many people will nod at this point, thinking that while liabilities have done well in rising markets, now things will be different. But I don’t believe it – and I’m not about to jump ship for a star active manager.
It’s hard to argue that names like James Anderson, Nick Train or Terry Smith – beloved managers who have outperformed their benchmark for decades – aren’t onto something. But since I have no idea what that something is, who’s to say it won’t stop working tomorrow?
Today, of the UK funds tracked by Morningstar, 25 that invest in US large-cap stocks are at least 15 years old. Let’s say you started following them 15 years ago. Then, after five years, you bought the five funds that performed best over that period. Ranked for their performance over the past decade, three of these funds would now be in the bottom five; one would have retained his place in the top five (at number five) and the other two would be in the middle of the table.
Star managers provide a compelling but dangerous narrative: the liveliness of their stories masks the low statistical odds of you picking the one who succeeds. The existence of the fund management industry depends on this triumph of hope over experience, relying on our propensity to cling to the handful of big-name performers.
While I like to think this insight keeps me away from the star manager trap, I suspect it’s more a matter of fear. That sinking feeling I get when my horse slips in the middle and then the back of the field is bad enough. How much worse to realize in 25 years, when I reach my retirement, that I would have done better to pay an algorithm to follow the index?
If ever I doubt my choice, I think of Neil Woodford. In 2017, its flagship fund managed over £10 billion. Two years later, as investors raced for exits, just £3.7bn remained and the fund was suspended. Investors are still waiting to get their hands on the rest of their money, with another delay announced this week.
Once the administrator is finished unwinding his investments, Woodford’s hapless investors will have the chance to recoup £2.7billion. Among their losses they can also count the remaining illusions about the performance of star managers.
The author is a freelance journalist