FOOL'S EYE VIEW
Trackers Continue to Beat Managed Funds

By Jane Mack (TMFJane)
February 20, 2003

The annual independent WM report, commissioned by Virgin Money, was published yesterday and, as usual, it points out, yet again, that active fund managers have consistently failed to beat index trackers over the long term. Over the last 20 years, 80% of fund managers performed worse than the market.

Considering active fund managers tend to claim that they are of particular value during a bear market, the report reveals that last year, during one of the worst stock market falls ever seen, 60% of them still failed to beat the market.

As Virgin Money Director Gordon Maw points out: "Even most fund managers admit that tracker funds are hard to beat in a rising market. However, the myth has persisted that a fund manager will give you better returns in a bear market. We now know that tracker funds beat the majority of fund managers whichever direction the market is heading in."

The report does say that fund managers are, after all, paid to invest in equities. As investors, we know this so we can hardly complain when they choose equities on our behalf only to suffer losses when the market falls.

This is a fair point but the fact is, it is possible for the investor to buy into the stock market without having to pay for the mistakes and the high charges that active fund managers make. An index tracker enables the investor to follow the market without the cock-ups that often result in even lower returns than a tracker would give you in a bear market.

Naturally, fund managers aren't happy with the WM report, not least with the figure that only 20% of their actively managed funds beat the market.

For example, ISIS Asset Management points out that these percentages are only based on the performance of the 48 funds that have been in existence for the 20-year period that was examined. (Only ten of them outperformed the index). They say that as most of the retail asset management industry simply didn't exist twenty years ago it's hard to come to firm conclusions based on such a small collection of funds.

However, the report states that because discontinued managed funds have not been included in their assessment of the last 20 years, this, in fact, has the likely effect of overstating the returns from active management. Investment funds tend to get shut down or gobbled up by better-performing funds if they perform badly. (Well, you wouldn't shut down one that was doing well, would you?) So, it follows that whenever you're looking at the past performance of a group of funds in existence today, you're automatically ignoring the performance of the worst ones.

The fact is tracker funds are cheap and beat most fund managers most of the time. And, they're even better if you invest in them within an ISA as the profits that you do make are protected from tax.

It's worth quoting a few of the key points made by the report:

• As equities provide higher rewards, they are risky assets to hold.
• The risk of equity underperformance diminishes with time. Investors with short time horizons should not hold equities.
• Once a time horizon has been identified and a strategy put in place, stick with it! Market timing is a fallacy. With hindsight, the benefit of moving judiciously between assets appears beguiling. We have never seen any compelling evidence that investors can successfully call major turning points in markets.
• Diversification is a major element in investing. Diversification eliminates much unnecessary risk within an investment portfolio or strategy. Furthermore, some part of an investor's holdings should also be in liquid (cash) form. Nothing is more dispiriting for an investor than to sell financial assets at depressed prices if they require to raise capital.

If you're investing in actively managed funds – and, if you're paying into any sort of pension fund, endowment policy or equity-linked mortgage, then you almost certainly are – you should read the report in full. It contains a very interesting section on the investing style of fund managers and how this affects their returns which is particularly worth reading.

As the report says: "Chasing performance is a fool's game". But please note they mean 'fool' and not 'Fool'.

Find out more about trackers in our Index Tracking centre.