IFA charges and portfolio risk

Prism

JohnWinder said:

 In the UK, the ratio of managed funds that outperform passive  is higher.  

Oh, no. GBP denominated active US stock funds don’t perform as well as local US funds do in the same sector.

The GBP funds perform better than US funds, as you say, in some areas like small cap. But that’s not relevant. What’s relevant is that the SPIVA reports show the majority of UK small cap funds and all others studied underperform their benchmark over 10 years. It’s not enough that they’re better at investing than US fund managers. If you chose a UK fund blindly you had a better than even chance of doing worse than an index fund last decade. No one’s described a reliable way to avoid that dross.

Yes, and as you also know from the same report the average performance from UK investors invested in UK region funds is better then the index and the asset weighted results are even better still. So no, it seems people are not picking blindly.

IFAs pay for the research or get a DFM to do it. DIY investors do their own research.

dunstonh

I'm still not sure if you have or haven't yet decided and moved funds.

Bonds have been moved but not gilts.

JohnWinder

Prism said:

Yes, and as you also know from the same report the average performance from UK investors invested in UK region funds is better then the index and the asset weighted results are even better still. So no, it seems people are not picking blindly.

IFAs pay for the research or get a DFM to do it. DIY investors do their own research.

Yes, that's some detail that seems relevant. But I don't see any comparison of average performances vs indexes. I see that most active funds underperform their index over 10 years (reports 1a and b), and risk adjusted returns were better for a bigger proportion of actively invested money in UK and EU (not EM, US or global) in report 4.

But if, as you suggest, a majority of money is being invested in the active funds which eventually outperform their index (and, obviously, their underperforming active brothers), and this money is being directed there by IFA's DFM's and DIY investors, we come back to the old question: how do I choose the IFA or DFM who will identify the next decade's outperforming active funds, rather than put me in the underperforming ones? Perhaps I have a better than 50% chance of picking one by chance, but the SPIVA data hasn't compared IFA's or DFM's, so we can't even say that.

tebbins

JohnWinder said:

Prism said:

Yes, and as you also know from the same report the average performance from UK investors invested in UK region funds is better then the index and the asset weighted results are even better still. So no, it seems people are not picking blindly.

IFAs pay for the research or get a DFM to do it. DIY investors do their own research.

Yes, that's some detail that seems relevant. But I don't see any comparison of average performances vs indexes. I see that most active funds underperform their index over 10 years (reports 1a and b), and risk adjusted returns were better for a bigger proportion of actively invested money in UK and EU (not EM, US or global) in report 4.

But if, as you suggest, a majority of money is being invested in the active funds which eventually outperform their index (and, obviously, their underperforming active brothers), and this money is being directed there by IFA's DFM's and DIY investors, we come back to the old question: how do I choose the IFA or DFM who will identify the next decade's outperforming active funds, rather than put me in the underperforming ones? Perhaps I have a better than 50% chance of picking one by chance, but the SPIVA data hasn't compared IFA's or DFM's, so we can't even say that.

The average performance vs indices is shown on pages 10 through 15 of the SPIVA year end 2020 full report.
You are more interested in the equal-weighted stats since you are choosing a fund, the asset-weighted stats don't matter as much.
Past performance is not a reliable indicator of the future.
You can compare funds yourself using tools on HL, trustnet, morningstar etc.
Your challenge is to pick the right IFA who is lucky enough to pick the right funds, which are lucky enough to hold the right stocks, over the right time periods, to generate outperformance in future.

JohnWinder

Thanks. I think the argument in favour of active in those areas where the active funds had on average better risk adjusted returns is that one has a better chance of outperforming the index than underperforming the index because more of the active fund money in these areas is in outperforming than underperforming funds.  And this will be the case because (your) new money flowing into these funds is likely to go in proportion to where existing money is viz, in the better funds. That seems valid to me: the 'system' somehow has managed to put more money into the better funds, so the same fate awaits my money.

How big is the benefit, compared to choosing an index fund, if you get one of the outperforming funds, on average? If I read report 4 properly, the annual risk adjusted returns might be 10% better each year (so, 8.8% rather than 8%), or as much as 25% (so, 5% rather than 4%). That's worth having.

So, accepting we're more likely to have our money placed in the 'better than index' funds (over a decade), how likely is it that they will continue to outperform for a more normal 30-40 year investing period? SPIVA says about 50% of UK active equity funds survive 10 years, down from 70% at 5 years. I suppose they're the better performing ones. But how many survive 30 years? And the ones who don't can only have crashed and burned, surely, unless that sector fell out of favour like bonds now.

Each annual 10 year SPIVA report is likely to differ a bit in their findings of active fund success measures. But considering the current report, in only EU and UK stocks was the average risk adjusted return of active GBP funds ahead of the index, although a large majority underperformed their index (if that's consistent!). We must wait to see if it's in those sectors where the out- or under-performance will be in 20 years.

If it's only the fund managers which explain the differences between the good, the bad and the index funds, then choosing active funds means you need to have some understanding and keep a close eye on the fund managers in case they change their approach, retire, get head-hunted etc. I know I don't have the skills for that, but I suppose that's what you pay advisors or DFM's et al 0.5%/year for.

Prism

The easiest part of selecting an active fund is not choosing a poor one. That means kick out all of the closet index trackers, most of the high street bank funds and most of the insurance based pension providers like Aviva, Scottish Widows etc. Thats a huge chunk of the active funds removed from the pool.

The harder part is to filter out the rest. US active funds struggle to beat the US index as its so well researched so unless you have very high conviction in a fund thats a difficult place to go active. The same with global as its over 50% US. So that leaves mainly UK, Japan, Europe. Larger companies in those regions are also fairly well researched so you might also be better off down the company size scale, accepting that there may be added volatility. So prime places are UK, Japan and European mid/small caps.

There are some exceptions of course. Scottish Mortgage invests wherever it wants completely ignoring any index - Large caps, small caps, emerging markets, unlisted companies - and does very well for it. Many UK equity funds use the whole all-share rather than just the FTSE 100. Avoid the biggest companies and chances are you get a better result. Fundsmith has done it based on quality and stock selection - it tends to move with the index until US earnings season when it usually jumps a bit based on the fact that the companies it holds often beat guidance.