Are investors now too passive?

Investors are increasingly settling for matching a market's performance rather than trying to beat it. But they could be missing a trick, says Piper Terrett.

Ever-increasing numbers of investors are ditching high-cost actively managed funds and buying passive trackers' such as exchanged-traded funds (ETFs).

These simply aim to track an index such as the FTSE 100 or the S&P 500 as closely and cheaply as possible, rather than beating it. But by always settling for just matching the market, could they be missing a trick?

Dan Hyde in The Daily Telegraph claims that "savvy investors" know that the chances of success with a tracker or an actively managed fund depend on "the region and the type of shares involved".

Areas such as emerging markets and small-cap stocks offer managers plenty of chances to outperform. In comparison, doing so is harder in highly efficient markets such as the US.

Research done by broker Rplan backs this up, he claims: while 61% of US active managers failed to beat the average US passive fund over five years, 66% of UK fund managers succeeded in doing so. In emerging markets, 74% outperformed, while in Europe an unbelievable 99% did so.

Do these findings blow a hole in the arguments for passive investing? No. There are two common problems in measuring fund performance that are likely to be at work. One is specifying the wrong benchmark.Comparing a US small-cap active fund against the S&P 500 tells you nothing about how well it's done, because small caps outperform large caps over time anyway.

The second problem is survivorship bias'. Fund firms often shut down underperforming funds, due to the difficulties of selling investments with a poor record. So when you look back at the past performance of active funds available today, the group will typically have better pastperformance than those that fell by the wayside.

These problems mean that different studies can produce very different results. For example, independent financial adviser AWD Chase de Vere found that the average active fund failed to beat its index in virtually all sectors including UK equities, European equities and emerging markets, according to a report in January again in The Daily Telegraph.

More importantly, rigorous research carried out by academics rather than by financial services firms consistently shows that the average active manager underperforms after costs. This doesn't mean that no active manager can beat the market long term, but finding those who are genuinely capable of doing it is tough.

If you're willing to do the work and develop the knowledge needed, it can be worthwhile. However, for most investors, the low-cost passive option is the best bet.

Recommended

A family-run investment trust to buy and lock away
Investment trusts

A family-run investment trust to buy and lock away

Menhaden Resource Efficiency made a slow start, but progress is encouraging. Buy before the discount closes, says Max King.
16 May 2022
James Anderson: innovation is still the key to returns
Investment strategy

James Anderson: innovation is still the key to returns

James Anderson, the man behind the Scottish Mortgage investment trust, tells Merryn Somerset Webb what he’d buy now
13 May 2022
Anna Macdonald and Mikhail Zverev: Investing in innovative new frontiers
Investment strategy

Anna Macdonald and Mikhail Zverev: Investing in innovative new frontiers

Merryn talks to Anna Macdonald and Mikhail Zverev of Amati about investing in growth-focused innovation in the teeth of a tech-stock selloff, and the …
12 May 2022
Looking for a hedge against inflation? The FTSE 100 might be a good bet
UK stockmarkets

Looking for a hedge against inflation? The FTSE 100 might be a good bet

There are no assets that will protect investors' wealth entirely against inflation. But the FTSE 100 – a global stockmarket index with a sterling hedg…
9 May 2022

Most Popular

Get set for another debt binge as real interest rates fall
UK Economy

Get set for another debt binge as real interest rates fall

Despite the fuss about rising interest rates, they’re falling in real terms. That will blow up a wild bubble, says Matthew Lynn.
15 May 2022
High inflation will fade – here’s why
Inflation

High inflation will fade – here’s why

Many people expect high inflation to persist for a long time. But that might not be true, says Max King. Inflation may fall faster than expected – and…
13 May 2022
Is the oil market heading for a supply glut?
Oil

Is the oil market heading for a supply glut?

Many people assume that the high oil price is here to stay – and could well go higher. But we’ve been here before, says Max King. History suggests tha…
16 May 2022