Active funds vs Trackers (again...)

Ginger_Red

A report that Hargreaves Lansdown have been running for the last few days gives a comparison of Active vs Tracker funds and unsurprisingly decides that managed funds are much better performers on average than trackers.

The modest amount that I know is that over time this is unlikely to be true, but loking at the simple charts they use to illustrate I can't see any flaws in their figures, apart from the fact that the two charts are over different periods of time.

Are they wrong, and if so, where is the report misleading ?

http://www.h-l.co.uk/news/feature-articles/active-versus-passive-funds

nrsql

It doesn't include anything to do with spread. Active funds might do better than trackers but that doesn't help if you choose an active fund that underperforms.

Would like to know what the UK All companies is measuring. If a fund doesn't exist for the 20 years is it included? Dog funds tend to be closed and if this isn't included will inflate the average performance.

One reason for active funds outperforming trackers is that they will active funds tend to cause changes whereas trackers react. If active funds sell a share that will depress the price causing the trackers to sell at the reduced price.
Note - on the graph there are times when the trackers outperform the uk all share.

ima definition of uk all companies is "Funds which invest at least 80% of their assets in UK equities which have a primary objective of achieving capital growth." which might skew it a bit.

Doesn't really matter - the idea of using a tracker is to avoid the poor performing funds - whether or not choosing an active fund at random is slightly more likely to outperfrom by a small amount is immaterial. Maybe a tracker that trackes the active managed funds?

Loughton_Monkey

Ginger_Red wrote: »

Are they wrong, and if so, where is the report misleading?

Having read the article, I wouldn't necessarily call it misleading, other than perhaps making it more black and white than it is.

I think they explain, reasonably well, some basic 'housekeeping' things that a 'manager' would do which will automatically provide better returns. Note that if you calculate the annual performance over the 20 years, we are talking about 1.440% per annum (tracker) and 1.596% (managed).

I look at it this way.

Imagine you had £20 million. You have a good idea that property prices in East London are going to rocket because of the Olympics. So you ask me simply to go any buy the first 100 houses, in that area, that I can find. Any houses, because you are only interested in capital value and making a quick buck. So I phone all the estate agents, do all the paperwork and charge you 0.25% (that's £50K). You pay stamp duty and legal costs. A year later, prices have jumped 10% and you have made 9.75% gross profit. My profit is probably £45K because I didn't have to do much.

Now imagine, however, that I suggested to you that by proper, experienced, and managed action, I could choose specific houses that will grow above average. But I'm now going to want a fee of 1.75%. You will probably go with this argument. You will envisage me hiring a team of surveyors, crawling over 300 houses, just to pick the 'cream' 100. My experience of property sales, and the local area is worth paying for....

At the end of the day, my portfolio goes up by 12%. After my cut that's 10.25%. You're happy. I have had £350K stuffed into my wallet. So I'm happy.

But here's the rub. When you learn that all I did was simply get in my car, and drive past all 300 houses on offer, simply eliminating the patently ugly ones, those with nasty extensions, those with a gypsy site next door, are you still happy? Probably cost me an additional £5K.

OK, a bit simplistic, but I think it's the same principle. Yes, you did better out of the deal, but somehow you feel ripped off!

Ginger_Red

nrsql wrote: »

Would like to know what the UK All companies is measuring. If a fund doesn't exist for the 20 years is it included? Dog funds tend to be closed and if this isn't included will inflate the average performance.

Yes, any funds not now operating are excluded, so as you say the dog funds have been erased from history.

Is one factor that they are looking at the "average" managed fund rather than the median ?

So if you pick a fund at random, the chances are it will underperform the tracker, and although there are a few stellar funds these are hard to pick because they don't remain stellar ?

yelf

havent read it yet, but statistics are there to be manipulated. I wonder what their argument would be against the Efficent Martket Hypothesis?

Loughton_Monkey

I am generally of the view (as my previous post) that IF managed funds really do beat trackers, then it is down to the most basic and simple 'housekeeping'.

One extra reason I say this is because apparently it is proven that if you look at the performance of all 'managed funds' in any specific sector (where the full range of 'possible' shares and investments is well known), then the variation in the performance of each fund is almost exactly the same variation you would get with the proverbial infinite number of monkeys picking the shares.

[I stress I am in no way comparing the fund manager community with an infinite load of monkeys. The number of fund managers is not infinite.]

koru

Loughton_Monkey wrote: »

I look at it this way.

Imagine you had £20 million. You have a good idea that property prices in East London are going to rocket because of the Olympics. So you ask me simply to go any buy the first 100 houses, in that area, that I can find. Any houses, because you are only interested in capital value and making a quick buck. So I phone all the estate agents, do all the paperwork and charge you 0.25% (that's £50K). You pay stamp duty and legal costs. A year later, prices have jumped 10% and you have made 9.75% gross profit. My profit is probably £45K because I didn't have to do much.

Now imagine, however, that I suggested to you that by proper, experienced, and managed action, I could choose specific houses that will grow above average. But I'm now going to want a fee of 1.75%. You will probably go with this argument. You will envisage me hiring a team of surveyors, crawling over 300 houses, just to pick the 'cream' 100. My experience of property sales, and the local area is worth paying for....

At the end of the day, my portfolio goes up by 12%. After my cut that's 10.25%. You're happy. I have had £350K stuffed into my wallet. So I'm happy.

But here's the rub. When you learn that all I did was simply get in my car, and drive past all 300 houses on offer, simply eliminating the patently ugly ones, those with nasty extensions, those with a gypsy site next door, are you still happy? Probably cost me an additional £5K.

OK, a bit simplistic, but I think it's the same principle. Yes, you did better out of the deal, but somehow you feel ripped off!

I think this analogy misses one crucial point, which is that in most stock markets there are thousands of very clever, well resourced fund managers who are all trying to perform as well as possible, and it is this that makes it very difficult to deliver sustained outperformance that justifies the extra fees charged.

To adapt the analogy, let's assume that there are thousands of other investors who have also spotted the opportunity to make a capital gain by investing in property close to the Olympic site and many of them also end up hiring professional advisers who want to charge a large fee in return for helping their clients choose the best houses to invest in. All this competition means that it is no longer as easy as eliminating the ones that are ugly etc, because all the other advisers can also spot these things, so the price gets bid up on the good properties and is lower on the bad properties. Or, any good properties that are underpriced get snapped up instantly, so you are very unlikely to get them. Therefore, you and almost all of the other advisers almost certainly cannot deliver outperformance. However, you still want your 1.75% fee, so the investor may not be any better off than the random picks; the only party who can be sure they are going to be better off if the adviser!

koru

Ginger_Red wrote: »

A report that Hargreaves Lansdown have been running for the last few days gives a comparison of Active vs Tracker funds and unsurprisingly decides that managed funds are much better performers on average than trackers.

The modest amount that I know is that over time this is unlikely to be true, but loking at the simple charts they use to illustrate I can't see any flaws in their figures, apart from the fact that the two charts are over different periods of time.

Are they wrong, and if so, where is the report misleading ?

http://www.h-l.co.uk/news/feature-articles/active-versus-passive-funds

The reason the report is misleading is that it is not comparing like with like.

As the report itself explains, the reason for the apparent difference in performance is that almost all of the trackers they will have looked at will be invested in the FTSE 100 or the all share index, which are heavily dominated by just a handful of very large companies. The biggest companies tend to have underperformed over the last decade, so this is naturally captured by those trackers that are tracking those indexes.

There are plenty of so-called active funds which effectively track the same indexes and these will certainly have done worse than the trackers, because of the difference in fees. However, Hargreaves Lansdown have looked at the total population of active funds, and so this will also include active funds which have genuinely stuck out their necks and have weighted their portfolios more heavily towards small and medium size companies, which tend to have performed better over the last decade. Some of these active funds will have done badly, because they made bad decisions, and some of the ones that did badly will have been closed, so they are not reflected in HL's figures. Some of the active funds will (because of the greater exposure to smaller companies) have done better than the index, so this drags up the average performance of active funds.

The misleading bit is to suggest that this is an inherent flaw of trackers, which is not correct. Certainly, most of the big tracker funds do track the main indexes and will therefore have a very big exposure to the largest companies. However, if you look around, it is not too difficult to find trackers which track other indexes, such as smaller companies indexes, or other countries. I don't know for sure, but I would bet that trackers that are tracking smaller companies indexes would compare much more favourably with HL's figures for actives.

In other words, all that Hargreaves Lansdown are really highlighting is the well-known fact that most of the performance of a portfolio is attributable to asset allocation. By asset allocation, I mean the choice to invest your money in equities versus bonds, large companies versus small companies, UK versus other countries. These decisions will have a huge influence over the performance of your portfolio. If you want to allocate more of your portfolio to, say, smaller companies, to get greater potential return and the corresponding greater risk, you can do it by investing in active funds or trackers.

It just so happens that over the last decade, allocating your assets to smaller UK companies as opposed to larger UK companies has tended to give better performance, so of course active funds which have the freedom (and have exercised that freedom) to take the risk of weighting their investments towards smaller companies have tended to deliver better performance (although this strategy is no guarantee of outperformance).

Arguably, the real lesson to learn from Hargreaves Lansdowne's figures is that trackers do not eliminate all difficult decisions. If you mindlessly plump for a FTSE 100 tracker, you might be missing out on better (or worse) performance by smaller companies, or by emerging markets, etc etc. You have to make asset allocation decisions, whether you go active or passive. But with passive you don't need to worry about manager selection: just choose the one with the lowest fees for your choice of index.

If HL redid their figures, comparing actives and passives that have the same broad asset allocation, I will bet that the average active performs slightly worse than the average passive.

Loughton_Monkey

koru wrote: »

I think this analogy misses one crucial point, which is that in most stock markets there are thousands of very clever, well resourced fund managers who are all trying to perform as well as possible, and it is this that makes it very difficult to deliver sustained outperformance that justifies the extra fees charged.

I'm really not sure about this. Well resourced? Probably. Clever? Not so sure. Some of these funds are small, others are over £1 billion. But take one, say, at £500 million. It is very clear, from tracker funds, that all the admin/paperwork/dealing etc. can be done profitably well within a 0.25% charge. So a 'managed' one will probably still eat up no more than 0.25% in 'costs'.

But that means, say, 1.5% - or £7.5 million. Now even if it's got a dedicated 'manager' (who doesn't manage other funds), and the odd 'boy' or two, we are not eating much into the £7.5m even allowing for their huge salaries.

Look at any specific fund, and its fact sheet year after year. Do you notice any change? Basically, the money is just stuffed into loads of shares in companies that meet the fund criteria (e.g. UK Smaller Companies). A few bits of paper will be shuffled every day to see if there are any new ones around who might fit the bill, but the only real 'decisions' made will be where to put the day's 'new money' (or what to cash in to pay the shortfall).

Most of the time, the answer will be 'same as yesterday'.

You can look at some of the more adventurous, active, alpha type funds. Here, I can envisage that there is a little bit more 'activity' and so-called 'expertise' that could be at play. These people (unlike the majority of bog standard managed funds) should be managing the fund. Shorting here, leveraging there, hedging derivatives to put in place, etc. But (a) this sort of fund charges more, and (b) performance variation is much wider, and boy are there some underperformers here. Some will hit the jackpot though. But by luck?

Maybe I'm a bit cynical (surely not), but I'd like to see a few new funds called something like "Bright young lad who reads the Investor's Chronical UK Equity fund." or perhaps "Middle aged FT reader with an hour to spare every day UK Corportate Bond Fund (Accumulation)". I wonder if they would beat the 'benchmark'?

jamesd

Ginger_Red wrote: »

A report that Hargreaves Lansdown have been running for the last few days gives a comparison of Active vs Tracker funds and unsurprisingly decides that managed funds are much better performers on average than trackers.

I trust that their result is accurate and it's not surprising.

The efficient markets theory is obviously false for the general case, since there are people and companies that have long records of outperforming trackers, beyond what can be attributed to chance, and have become famous for doing so. It's still a useful generality for models, because most professional investors aren't as exceptionally capable as the most famous cases and because those famous cases have to be achieving their better results at the expense of someone else: the less capable people.

Even with trackers, there's a broad range of costs, from 0.1% or so for a FTSE All Share Index tracker fund to 1% or more for another fund tracking the same index. If you want better performance from a tracker, don't choose one with high fees, because it's just tracking and won't have a way to deliver extra performance to compensate for the extra charges.

When it comes to managed funds, the same initial logic applies: start by eliminating those with a consistent record of doing less well than average. Maybe it's high fees, maybe it's less willingness to hire good people and invest in good systems. Whatever the reason, you don't have to buy, you can pick one without those handicaps.

You still may not come out ahead, but at least you've eliminated the proven failures from your options.

If you don't want to do much work, pick a tracker. Not much work implies that you're not going to spend the time to select and monitor a managed fund and its management and that will give you a disadvantage that can be eliminated by using a tracker. Most people fall into this category, particularly when it comes to pensions. So know yourself and pick a tracker if you're not going to pay regular attention.

Even if you think that active funds can do better, that's not sufficient reason for always using them and never using trackers. Pick the best for the situation you think you're in.

payless

personally ( I don't advise on investments) I suppose what I do would be classed as a core / satellite approach.

Low cost trackers give me access to large cap/ market trend and I can then invest in individual shares/sectors myself ( albeit the usual approach is to use a manager for the latter).