Funds: Stick with your trackers

Here at MoneyWeek, we regularly remind you that the average active fund manager is rarely worth the money you pay them to pick and choose stocks in their efforts to beat the market. That's because most of them fail to beat the market over any prolonged period of time. And that doesn't look like it's going to change anytime soon. Another new study has revealed that 86% of actively managed funds in Europe have failed to beat their benchmark over the past ten years. The frankly atrocious results were identified by S&P Dow Jones Indices in its latest S&P Indices versus Active Funds (SPIVA) scorecard.

Some of the results are really quite staggering. For example, over a period of five years, not one single actively managed fund in the Netherlands managed to beat the domestic equity benchmark, and over ten years, fewer than 4% managed to do so. Similarly, just over 12% of Danish fund managers beat their index over five years, and fewer than 6% over ten.

But while we can feel sorry for Danish and Dutch investors, focusing on the more eye-catchingly bad figures in the study draws attention from the key point being made here: paying extra money for an active manager to try to beat the market, rather than simply investing in a cheaper passive fund (that merely aims to track the index, less tracking costs), rarely pays off. And the longer the timescale you are investing for, the trickier it becomes for an active investor to deliver outperformance consistently.

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Take European funds that focused on emerging markets, for example. In 2015, just 25.1% beat their benchmark. That slid to just under 18% over three years, just under 11% over five years and a pathetic 3% over a full decade. This is particularly revealing, as emerging markets are meant to be precisely the sort of markets where active managers earn their crust. As the SPIVA report puts it: "There is a widely held belief that active portfolio management can be most effective in less efficient markets, such as emerging-market equities, as these markets can provide managers the opportunity to exploit perceived mispricing. However, this view was not substantiated by our research."

One bright spot of sorts is that UK-focused funds actually performed slightly better than many of their peers. After a year, around 78% of UK-focused funds beat their benchmark. And after ten years, nearly 30% of UK funds still managed to outperform. That compares to just 5% of US-focused funds. But that still gives you a far less than 50/50 chance of buying and holding for a decade and being happy with the result.

These figures are hair-raising, but they're nothing new. Plenty of studies have backed up these data. As David Blake, director of the Pensions Institute at London's Cass Business School, told the Financial Times: "The average equity fund manager is unable to deliver outperformance from stock selection or market timing This means a typical investor would be almost 1.44% better off per annum by switching to a UK equity tracker."

So should you avoid all active funds, and pile into cheaper, passive funds that try to follow rather than beat the benchmark? The research suggests that once you have chosen an area you want to invest in, passive funds should be high on your list in most cases you'll be paying less for a better peformance than you'd get from an active fund. We wouldn't rule out active funds altogether some do outperform without costing the earth, and we're keen on many investment trusts (view the MoneyWeek model investment trust portfolio). If you do go active, avoid closet trackers, which just hug the index seek out managers with high conviction and a relatively small number of holdings in their portfolios.