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OPINION

Money for old rope?

Money for old rope?
May 15, 2015
Money for old rope?

But Mr Hargreaves is not the first to suggest that fund managers are rather unimpressive. Back in 1966 Jack Treynor and Kay Mazuy of consultancy Arthur D. Little argued that there was “no evidence to support the belief that mutual fund managers can outguess the market”. Our own Chris Dillow has regularly addressed this question, as new research is published – tellingly, he keeps his wealth in a few carefully chosen tracker funds and often suggests that those readers’ whose portfolios we review in the magazine each week could similarly benefit from simplifying often disparate fund holdings, to avoid duplication, remove 'closet index trackers', and reduce costs.

That last point is critical. Countless studies have shown that such costs contribute to consistent underperformance against cheap trackers, yet the asset management industry, which we discuss in this week’s sector focus, continues to do rather well. So why do so many investors keep buying their products? One is that inflated expectation of the returns they’re likely to receive means they underestimate the significance of those costs. What difference does a couple of percentage points a year make when the performance (or, more accurately, past performance) is five times that? (A lot is the answer, especially when equity returns are more likely closer to five) What’s more, less confident investors are happy to outsource the process to someone they assume knows better or has an advantage over the individual.

There is some truth to this last point: institutional investors have much better more access to management and research than the man on the street. Besides, which, we should be careful how we interpret statistics suggesting fund managers are so poor. According to Bank of America research only one in five managers beat the market in 2014. Case closed? Not quite - according to analysis by Premier Asset Management, active managers trounced trackers in the five years to 2013. It's likely, therefore, that the performance differential isn't a specific investment failure, but the result of which class of equities are doing well at any given time (in 2013, a particularly good year for active managers, it was smaller companies, suggesting they add value here).

Private investors do have some advantages though, not least that they don’t have bosses and investors to account to, and limitations on their investable universe. But it is wrong to dismiss a whole industry as useless, and in fact private investors could do a lot worse than following than some of their best practices. We outline ten of them in this week’s cover feature.