#SFTW Sorry, active managers — indexing will get even better
Posted by Robin Powell on July 8, 2016
SOMETHING FOR THE WEEKEND
I’m not against active management as a matter of principle. As soon as there’s an active fund that’s worth investing in, I’ll be only too happy to say so. But I’m not hopeful I’ll be able to do so any time soon.
The main reason is that, as things stand today, the active fund industry is completely unfit for purpose. There are far too many funds, charging far too much and providing too little value, if any at all, in return. Of course, we may see an improvement but, to quote Anthony Hilton in the Evening Standard yesterday, “inertia is almost guaranteed because so much is entrenched, there is so much self-interest and so many people have a vested interest in the status quo”.
There is, however, another reason why I’m distinctly pessimistic about the future of active management. That is that the alternative — passive investing in all its forms — will actually get better and better.
It’s almost impossible to identify a star manager in advance
Pick up any investment magazine, or browse the money pages of a newspaper, and the impression given is that picking winning fund managers is relatively straightforward. But the truth is very different. Choose a fund today and the chance that it will beat its benchmark consistently over the long term is somewhere in the region of 1%.
No wonder the funds featured in the media are funds that have outperformed in the past. Those are just the funds the industry promotes and that journalists like to write about.
Never stop asking questions
Of all the major news stories of the last 25 years I’ve always taken a particular interest in Iraq. The First Gulf War in 1991 was one of the first big stories I worked on as a television journalist.
Eight years later I went to Baghdad to report on the effects of economic sanctions on ordinary Iraqis and efforts being made by the Anglican Church to foster reconciliation between Iraq and the West and between the different religious factions within Iraq itself. Over the years I’ve also met the relatives of British servicemen who lost their lives in the Second Gulf War and its aftermath.
I had, therefore, eagerly anticipated the publication today of the Chilcot Inquiry into events leading up to Britain’s involvement in the invasion of Iraq in March 2003.
Yet another problem with hedge funds
As any regular reader of The Evidence-Based Investor knows, investing in hedge funds is a bad idea. The fees they charge are astronomical and the performance they deliver, in aggregate, has been consistently dismal for many years.
But there’s another fundamental reason to avoid hedge funds like the plague, and it’s this: they don’t even hedge.
Friction cost — the biggest single drag on your returns
Most people have never heard of it. The industry doesn’t talk about it and you rarely read about it in the media. But friction, or frictional, cost is a concept that every investor needs to understand.
In short, frictional costs are the direct and indirect costs entailed in the execution of financial transactions.
Now you might be thinking, How complicated can it be to manage my money? But you’d be surprised. When you invest in a pension, a chain of up to 16 different “professionals” have to be paid. As well as the fund manager, there’s also the fund “platform”, researchers, brokers, the stock exchange, the individual settling the trade, the custodians of the fund and so on.
Were you blindsided by Brexit bias? (Tim Richards)
20 cognitive biases that screw up your decisions (Business Insider)
What did Benjamin Graham say about managing emotions? (Ben Carlson)
Also worth reading
The death of active management (Eric Nelson)
Take a simple idea and take it seriously (Morgan Housel)
Bogle, Buffett & other living legends of the investing world (Barry Ritholtz)
Your biggest financial asset is your ability and willingness to work (The Happy Philosopher)
The active vs passive distinction is out of date. We need to find new terms (John Rekenthaler)
My colleagues and I at Regis Media always value feedback on what we’re doing. But we were especially heartened to receive the following message earlier today from a wealth management firm we’re working with in the Middle East:
“I would like to say how great I think your work is. Robin’s blog and linked in updates are inspirational to us and your videos are really well put together. Well done for all the very hard work that I know this entails.
“The purpose behind all of your content is in my view the best thought out/ put together that I have come across and I genuinely look forward to looking at it and helping distribute it to those people whose lives we are collectively trying to improve.
“We feel very privileged to have come across your great organisation at such an exciting time when we feel there is a huge opportunity to help people secure themselves substantially better financial futures through following your guidance/approach.”
Thank you, guys — you’ve made our day!
Please note: The next edition of Something for the Weekend will be in a fortnight’s time.