Active fund management is not the Holy Grail

We keep hammering on about this, but we’d thought it was time to give active fund managers another bashing.

Why? Because Dimensional have recently carried out an interesting study of the mutual fund landscape in the US, and their findings are generally replicated in the UK.

Here’s an overview of the results:

  • A majority of fund managers in the sample failed to deliver benchmark-beating returns after costs
  • Just because a fund performed well last year, it doesn’t mean it will perform well again – remember that quaint old saying: “Past performance is not necessarily a guide to future performance.”
  • Bad funds just ‘disappear’ because it’s not good marketing to mention them
  • The best barometer of success is costs as we have mentioned before e.g. Overheard in the pub
  • It is more costly to turnover your investments regularly than it is to buy and hold them (the latter is what we do at Plan 100)

Please keep reading for more details.

Surveying the landscape

Dimensional looked at over 4,000 mutual funds throughout 2016, collectively managing $2.69 trillion. Many of the funds evaluated did not outperform benchmarks after costs.

Disappearing funds

Each year, many poorly performing funds quietly disappear. In fact, only 17% of equity funds and 18% of fixed income funds have survived and outperformed their benchmarks over the 15 years up to 2016.


The search for persistance

A fund’s past performance is not enough to predict future results.

Over the 10 years until 2016, top-quartile persistence of five-year performers averaged just 23% for equity funds and 27% for fixed income funds.

Sadly for active fund managers, it seems that track records do not provide enough insight to identify management skill. Impressive track records result from good luck – which you can’t rely on.

Costs matter

The data shows that high costs reduce performance.

Funds with higher average expense ratios had lower rates of outperformance. For the 15-year period until 2016, only 9% of the highest-cost equity funds and 19% of the highest-cost fixed income funds outperformed their benchmarks.

All mutual funds incur costs, but high costs reduce your net return as an investor.


Costly turnover

Trading costs impact a fund’s returns, and the highest the cost, the higher the outperformance hurdle. To put it another way, funds with higher turnover are more likely to underperform.

For all periods examined, equity funds in the highest average turnover quartile had the lowest rates of outperformance. For the 15-year period until 2016, 10% of the highest-turnover funds outperformed.

In summary

  • Outperforming funds were in the minority
  • Strong track records failed to persist
  • High costs and excessive turnover may have contributed to underperformance

Sorry that this article gets a bit technical in places. If you have any questions, we’ll be happy to explain. Just give us a call on 01435 863787.

Lance Baron

Certified Financial Planner (CFP) based in East Sussex, UK. We support people in Southeast England with more than £500K to invest by building a financial plan that will help them live the life they want… until age 100