This weekend the Telegraph published an article which made me very angry. It was about fund managers, used by pensions eg your employer pension, underperform the market eg by 30% over 3 years and still charge millions in fees to their clients. These funds were managed by St James’s Place, Halifax, Hargreaves, Invesco, JP Morgan, and other household names.
This infuriates me because:
- You probably don’t know you could ask them by how much they are underperforming
- You don’t know you can have a SIPP you control
- You don’t know you could just use an index tracker bought through an online broker and beaten the expensive managers
- The managers don’t give you the fees back for being rubbish at their jobs for 3 years and making your retirement poorer
Consider this:
The last SPIVA scorecard showed that 69.33% of UK equity fund managers underperformed the S&P United Kingdom BMI Index over the past decade.
In the US market, the picture is even bleaker: 87.2% of all active funds underperform their benchmark between 2005 and 2020.
During the COVID-19 pandemic crash and the early stage of the recovery, things weren’t much better. According to research published by the University of Chicago, almost 3 in every four active funds underperformed the S&P 500.
This sustained underperformance is a worry for pension investing fund managers. When discussing active vs passive funds, the common refrain is that active funds are perfectly positioned to take advantage of the market in times of significant volatility. However, these figures blow that argument out of the water.
Call me old fashioned, but if the entire premise for active funds is that they outperform passive funds, I’d expect that to happen more than half the time.
The Reasons Why Active Fund Managers Are Failing
While on the one hand, these poor results are shocking; on the other, it’s not entirely surprising. There are clear reasons for the poor performance of active funds.
Since the 1960s, the financial markets have undergone a process of professionalism that has resulted in a hyper-educated, hyper-competitive industry. Portfolio management is a zero-sum game that requires fund managers to out-skill other fund managers to make a profit. The result? Your average active fund manager doesn’t have an edge in their market.
In a less professional or less informed market, active fund managers were able to triumph. But now — as evidenced by the SPIVA scorecards — being one of the 15-25% that outperforms passive funds is incredibly tough.
Additionally, there are drawbacks to active funds that limit how conducive they are to the ups and downs of long-term success. Long-term stock market success often requires the will to hold on to a poorly performing but high potential stock in the short term. However, it is easy to lose investor confidence — or your fund manager job — during these downswings.
Additionally, as pointed out by this research, funds that do outperform their benchmark over 15 years spend 60-80% of that time underperforming. These statistics require an iron will and the understanding of investors.
I say all this not to make it seem as if active fund managers are buffoons who are so incompetent that they are failing to beat the market — although that is an opinion held by researchers like Cass Business School’s David Blake.
On the contrary, these are smart people stuck inside a tough trading discipline. But whatever the understandable causes, their suitability for good pension investing must be called into question.
Some of the other factors that affect active fund performance are fees and taxes.
Taxes
Active funds need to time the market to turn a profit. Buying and selling incur transactions costs that affect the fund’s returns. Additionally, profits lead to capital gains that are passed on to the shareholder.
Fees
Active funds have fees that eat into the returns. Fund managers charge 1-2% per year in management fees, compared to 0.1-0.2% for passive indexing. Additionally, sales charges can apply when you buy or sell the fund, frequently totalling around 4-8%. These charges compound over the years and negatively affect returns.
