New analysis has the answer
A look back over 10 years reveals the markets where human fund managers are most likely to earn their keep
British savers had a 50:50 chance of picking an “active” fund that managed to beat simple automated rivals over the past decade, research for Money Telegraph has established.
The study, by Morningstar, the data firm, worked out how many funds run by a human stock-picker beat the best performing “tracker” funds in six regions over various time frames.
The data, summarised in the graphic (see page 3), makes interesting reading at a time when investors are increasingly turning their backs on City stock-pickers and turning instead to tracker funds, which offer low-cost exposure to a particular stock market. Three years ago tracker funds held £60bn of British savings, but this figure has now leapt to just shy of £100bn.
Some of the results are surprising and conflict with previous academic studies which concluded that a monkey with a pin could do a better job picking shares than a highly paid fund manager.
What the chart shows
The graphic outlines the chances of an active fund manager beating the best-performing tracker of the relevant index over the past three, five and 10 years. The six markets picked – the UK, US, Europe, Asia, Japan and global markets – are among the most popular with British investors. Our analysis looked at “growth” funds, those that aim simply to increase in value over time, and did not include income funds.
Active funds fared better relative to trackers over the longer time frames in the study.
This was especially true of funds that buy European shares, with 70pc of actively managed European funds beating the best European tracker over 10 years. Among Asia funds, 55pc of active portfolios beat the best tracker over a decade, while the figure for the UK was 52pc.
Forty-eight per cent of global funds with human managers outperformed the best passive fund over 10 years, compared with 38pc of Japanese funds. In last place were active US funds, only a third of which managed to beat the top tracker.
Overall, 50pc of active funds beat tracker funds over the past decade. The figures are net of fund charges.
What the experts say
Financial advisers such as Philippa Gee, of Philippa Gee Wealth Management firm, said the data showed savers should not favour one strategy over the other and should instead hold a mixture of the two.
“It [belief in either active funds or trackers] has become a religion to some investors, to the extent that they are not prepared to weigh up the other side of the argument and will only talk up the merits of one strategy and criticise the other,” she said.
“When I invest personally and for my clients, I use both. Tracker funds are better in some markets and much cheaper, but there are certain fund managers who deliver superior returns and are worth paying a premium for.”
Our findings, which found a one in two chance of picking an active fund that outperforms, paints fund manager as more skilled than other research has done in the past.
Last summer the Pensions Institute at Cass Business School, the respected academic body, issued a damning study into active funds. It found that 99pc failed to beat the stock market between 1998 and 2008, returning an average of 1.4 percentage points less than the market each year.
Professor David Blake, the author of the research, said at the time: “Based on the findings, just 1pc of fund managers are ‘stars’ who are able to generate superior performance.”
Commenting on our research, Prof Blake said: “Over the longer 10-year horizon, the results in most markets tend to converge to the 50pc level – that is, an equal chance of outperforming and underperforming the market. This is what you would expect.
“Ultimately investors need to decide whether they want to flip a coin. The three and five-year numbers flatter the active funds due to the bull market equities have enjoyed since the financial crisis and are not an indication of fund manager skill.”
Why do fund managers perform better in certain markets?
As the chart shows, the chances of an active fund beating a tracker vary from one region to another. Experts say there are reasons why fund managers are able to gain an edge in certain markets and not in others.
Jeremy Beckwith, an analyst at Morningstar, said shares in smaller companies, which have more scope to grow quickly than their larger peers, were poorly represented in tracker funds because the funds’ stakes are proportional in size to the companies’ representation in the index.
In the UK, for instance, the FTSE All Share Index, which most tracker funds aim to replicate, is dominated by the 10 biggest companies. These heavyweight shares, which include BP and Vodafone, make up more than a third of the index.
A fund that can take significant stakes in small companies has the scope to outperform a tracker, whose fortunes are strongly influenced by this small group of huge companies. (It also has more scope to underperform, of course.)
In the case of Europe and Asia, successful fund management is all about buying the “right countries”.
Mr Beckwith said: “Both economic and political factors can change quickly and either negatively or positively impact on how that country’s stock market performs. The fund managers are paid to switch the money around when they see fit to either take advantage or protect capital, whereas the tracker funds do not have this freedom.”
The fact that active funds in America struggled to beat trackers will come as little surprise to the more experienced investor.
The majority of US funds, over both short and long time periods, fail to beat the S&P 500 index.
Why a tracker fund works in Europe but not in the US (for now)
Fund analysts say this was because so much attention was lavished on American companies, with analysts poring over their accounts, making it tough for US fund managers to find mispriced shares.
Mike Deverell of Equilibrium, the wealth manager, said: “The US is seen as a very efficient market with every stock followed by hundreds of professional analysts. This makes it very difficult to spot a bargain. We only use tracker funds for clients who want exposure to America.”
But the analysts could not put their finger on why Japan funds fared so badly. Mr Beckwith suggested: “Perhaps it is just because there are not many decent fund managers who invest in the region.”
Is the data reliable?
Yes, but as Prof Blake said, the bull market since 2009 may have helped active funds.
There is, however, another factor that could have given active funds a boost relative to trackers over the past 10 years. At the start of that period tracker funds were much more expensive than they are today. This will have put their average cost over the period up and reduced their returns after fees were taken into account.
Ms Gee said: “It has only been in the past five years or so that tracker fund costs have come down. Some had fees similar to active funds, but some are now 10 times cheaper.
“It will be a different story over the next 10 years. Active funds now have a much bigger hurdle to beat, given that today the cheapest trackers cost as little as 0.09pc and active funds tend to charge 1pc.
“There is now a bigger gap for fund managers to bridge and only the most skilled investors will be able to do it.”