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FAKE NEWS! Active outperforms passive!

FAKE NEWS! Active outperforms passive!

Unfortunately, we now live in a world of fake news and ‘alternative facts’[1] where parties shamelessly push their own agenda at the cost of salient facts.  In order to be heard in the noise of social media, research headlines need to be bigger and more eye-catching.

For those investing using an evidence-based approach that means it is important to make sure that any evidence being reviewed is based on true facts, reliable data and sound research methodologies.  There is much good research and empirical evidence available, but some of a lesser quality occasionally make the headlines.

A recent piece of research by a fund management firm that manages over US $580 billion[2] is a case in point, making the statement:

Active funds beat passives in every market in the UK over a 20-year period’

That is quite a claim to make.  The firm looked at funds in seven Lipper categories[3] and – somewhat surprisingly for an investment house filled with bright and talented people – compare how the fund with the best performance over the past 20 years had done relative to passive alternatives (index funds) and the index.  The methodology is so evidently flawed as to hardly be worth reviewing. It is best summarised as requiring a fund-picking strategy of perfect 20-20 hindsight!  They concluded that it would have been worth identifying the best active fund instead of using a passive fund. The problem is that this is almost impossible to do without a crystal ball.

Alan Miller of SCM Direct – a firm which has campaigned to improve investor outcomes – summed it up most effectively:

It’s a bit like saying you’re better off buying a lottery ticket than putting your money in the bank because had you won the lottery each year, you’d have done much better.’

Unfortunately, this type of naïve research risks misleading retail investors, and even some advisers, against a sensible evidence-based approach suggesting that a passive approach makes good sense.

In their own data, the fund management firm in question revealed that in the six Lipper categories where there was a passive fund with a 20-year track record, in five the average passive fund beat the average active fund.  In the sixth, there was nothing much in it.  The best passive fund – which you do have a fair chance of identifying, unlike an active fund – outperformed in all six categories.  Another methodological flaw arises; no account seems to have been taken of the high proportion of UK-based funds that would have failed to survive the period.  A reputable study[4] reveals that only around 50% of GBP-denominated funds survived the 10-year period to the end of 2022.  Over 20-years this figure is likely to have been even worse.  We also know from this study that, on average across the eight categories of funds denominated in GBP (so a similar fund set to the flawed research above), 80% of active funds failed to deliver on their promise of beating their market benchmark over 10-years.  For a 20-year period this is likely to be higher, as evidenced in the US version of this study.

‘Enough, already!’ as our American friends might say.

At Wells Gibson, we want you to enjoy a successful investment experience and believe investing should be guided by decades of empirical evidence. We approach wealth planning and management with one very clear objective — securing a financial future for you and your family that is focused on a lot more than just making you more money.

If you have any questions in relation to this article, please get in touch with a member of the Wells Gibson team.

Risk warnings

This article is distributed for educational purposes only and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Reference to specific products is made only to help make educational points. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

[1]     This was a term used by White House adviser Kellyanne Conway to defend an untrue statement about the number of people attending President Donald Trump’s inauguration.

[2]     As reported in–do-its-claims-stack-up/

[3]     Lipper is a data provider who break down the fund universe into categories such as global equities and emerging market equities.

[4]     SPIVA Europe Year-End 2022 Report