Robin Powell: Hello again. Ask a financial adviser to recommend a mutual fund, and chances are they’ll suggest an actively managed one. The funds you see advertised or mentioned in the media also tend to be active.
And yet independent and peer-reviewed academic research has consistently shown that, after costs, actively managed funds only very rarely outperform low-cost passive funds with any degree of consistency.
Prof Keith Cuthberston: My work, which applies to partly to the US, sometimes to the UK, and also to Germany, suggests about 70 percent of funds are just closet trackers. So you’re paying them a fee for something you could really do yourself. About 20 percent your grandma could do better than them. So, they actually remove value from the investment process. And about 5 percent probably are skilled managers. But having said that, they are probably harder to find than the Higgs Boson.
RP: It’s hard to imagine any other industry surviving - let alone thriving - when only about 5% of its products actually work. But in fact, it’s worse than that because academics say it’s almost impossible to tell whether the winners outperform as a result of skill or simply by random chance.
KC: If you put a large number of monkeys on a large number of typewriters for a large amount of time one of them will type out to be our not to be. But you don’t necessarily hire that monkey to write your next play.
RP: When you take random chance into consideration, the number of fund managers who outperform consistently through genuine skill is even smaller. And, of course, the challenge is to identify future star performers in advance.
As Professor Cuthbertson says, investing in active funds is effectively a gamble. One explanation for why so many of us do it, he says, is that people like gambling. He also thinks the media is partly to blame.
KC: When you see gurus on the telly, I mean, sometimes people who are not that clever always sound very precise and cocksure. Whereas somebody with a slightly more intelligence is always a bit circumspect uncertain. And it’s always the one-handed guru, rather than the two-handed one, who seems to win. And people, you know, put their money that way.
RP: Having strong convictions might be a useful characteristic in some aspects of life. But not when it comes to investing.
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