Once again – active fund managers are no better in bear markets than in bull runs

Active fund managers claim to provide more value than passive funds when the market is falling. But that simply isn’t true, says John Stepek. Here’s why.

Investment screens © DANIEL SORABJI/AFP/Getty Images)

When markets are falling, active fund managers underperform

Investment screens © DANIEL SORABJI/AFP/Getty Images)

How many times have you heard this old chestnut?

"Passive funds are fine when the market is going up. But when the market falls, and the bear starts to bite, that's when active managers really earn their keep."

It sounds like it makes sense. Passive funds can only follow the market up and down. They can't take action to insulate you from a fall. If the market crashes, so does your passive fund.

An active manager, on the other hand, can take evasive action. And they can hold more cash something a passive fund can't do.

It all makes a lot of logical sense.

Sadly, it's also tripe.

Guess what? Most active managers underperform when markets fall too

In the year to the end of June, just over 80% of UK equity fund managers failed to beat the UK index. That's according to the latest scorecard from S&P Dow Jones Indices.

What's all the more painful for active managers, is that this came at a time when they're meant to demonstrate their value (at least, according to popular myth).

The latter half of last year was a rough year for markets. Indeed, it's easy to forget now because the early 2019 rebound was so strong, but in the last quarter of 2018, markets really fell hard. It looked as though it might all be over.

And yet, despite the widespread bear market, active managers failed to take advantage.

As Andrew Innes of S&P Dow Jones points out, "the steep declines seen across equity markets in late 2018 were accompanied by near-ubiquitous underperformance across the fund categories' asset-weighted returns."

In other words, while markets fell, active funds fell harder. And that goes for whichever benchmark you want to choose.

Worse still, the managers were unable to make the money back during the rebound in 2019. Talk about adding insult to injury for their investors, at least.

The one thing you can take charge of

We've said it many times before and I'll warrant we'll say it many times again in the future: if you want to maximise your returns as an investor, the key thing to focus on is costs.

None of us can predict the future. And even if you did know what was going to happen next, markets in general take an almost perverse delight in confounding expectations. So you can never be sure of how they're going to react in a given situation.

So you have to focus on the things you can control. The nice thing about doing that is that it narrows down your options very rapidly. Because as an investor, there's very little you can control.

You don't know which active fund manager is going to be the one to succeed (you can increase your odds of finding them stick to investment trusts but that's a story for another day). You don't know what the Bank of England and the US Federal Reserve are going to do next. You don't know how Brexit is going to turn out, or how the market will react if it does.

But there's one thing that you can control: how much you pay to invest.

One of the main reasons that active managers struggle to beat their benchmarks is because they not only have to beat the average, they also have to make enough on top of that to pay for their own fees before you start seeing the benefit.

This, of course, is where passive funds come in. Passive funds don't try to beat the market. Instead, they aim to track the market. Tracking the market isn't hard, because you just have to invest in the same stocks that the market does.

In turn, that means that the fund doesn't require an expensive fund manager or management team to run it. As a result, it can charge lower fees.

So you have a fund that promises to give you the average in a world where achieving the average is counterintuitively an above-average result. Not only that, but it promises to deliver you this result at a lower cost than any active fund.

In short, if you want to invest the straightforward way and you have no desire to spend ages picking over research to try to find the best fund manager (and potentially then getting it wrong anyway) then you should favour the passive route every single time.

Don't get me wrong this is just the beginning. You then still have to consider which passive funds you might buy. That all comes down to your asset allocation how much money do you want to invest in bonds? How much money do you want to invest in equities? Which bond markets? Which equity markets?

This is a topic I've covered many times before, and which I will no doubt cover many times again. But, for now, this is the point to bear in mind: watch your costs. Over a working lifetime it can make tens or even hundreds of thousands of pounds of difference to your eventual retirement pot.

This will, incidentally, be among the very many topics we'll be discussing at the MoneyWeek Wealth Summit on 22 November. If you are at all interested in how to better protect and grow your wealth, then I suggest you book your ticket here.

Recommended

Gold has been incredibly boring to own – but that’s no bad thing right now
Gold

Gold has been incredibly boring to own – but that’s no bad thing right now

Stocks, bonds and cryptocurrencies have all seen big falls this year. But gold remains at its one-year average. It may be dull, but it’s doing what it…
29 Jun 2022
How to find the best dividend stocks
Income investing

How to find the best dividend stocks

Stocks that pay dividends tend to outperform the market over the long run - as well as providing an income. Here, Rupert Hargreaves explains the best …
28 Jun 2022
What the end of the 1970s bear market can teach today’s investors
Stockmarkets

What the end of the 1970s bear market can teach today’s investors

The 1970s saw the worst bear market Britain has ever seen, with stocks tumbling 70%. Things have changed a lot since then, says Max King. But there ar…
28 Jun 2022
A Europe-focused investment trust that’s back on form
Investment trusts

A Europe-focused investment trust that’s back on form

Alex Darwall’s European Opportunities investment trust deserves another look after a difficult spell, says Max King.
28 Jun 2022

Most Popular

Prepare your portfolio for recession
Investment strategy

Prepare your portfolio for recession

A recession is looking increasingly likely. Add in a bear market and soaring inflation, and things are going to get very complicated for investors, sa…
27 Jun 2022
Market crash: have we hit bottom or is there worse to come?
Stockmarkets

Market crash: have we hit bottom or is there worse to come?

For a little while, markets looked like they were about to embark on a full-on crash. And that could still happen, says Dominic Frisby. Today, he look…
27 Jun 2022
What the end of the 1970s bear market can teach today’s investors
Stockmarkets

What the end of the 1970s bear market can teach today’s investors

The 1970s saw the worst bear market Britain has ever seen, with stocks tumbling 70%. Things have changed a lot since then, says Max King. But there ar…
28 Jun 2022