Why trackers beat active funds

published 10 July 2006

Recent analysis from fund management group New Star confirmed what many sceptics have been saying for some time: fund-manager performance is based more often on luck than skill. After looking at the number of fund managers who outperformed the median over the last three and five successive years, it found that only one in eight had done so over three years. The number was even smaller over the last five years, when only one in 34 did so.

In other words, "the chances of a fund manager beating the average are no better than tossing a coin", says Philip Coggan in the FT. That would suggest that your money is better off with an index-tracker fund and Coggan points to a recent US survey that revealed that the average index fund beat the average actively managed fund by 2% a year over the long term.

Index-tracking funds

That may well be the case, but as Justin Modray of Bestinvest tells Reuters, investors in trackers are not getting as much diversity for their money, which is important in spreading risk. That's because the FTSE 100 is overwhelmingly slanted towards corporate giants, meaning price movements in their sectors have a major impact on the value of trackers. "You have to have a diverse portfolio to stand a chance of winning," says Phillipa Gee of IFA Torquil Clark; dull and lifeless tracker funds can't do that. But as Warren Buffet says, "wide diversification is only required when investors do not understand what they are doing." In other words, making serious money isn't about putting your eggs in different baskets, it's just about finding the right one.

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Hedge Funds

But when it comes to hedge funds, your money would be better invested in a tracker. According to the Credit Suisse/ Tremont index of hedge-fund returns, over the last five years, hedge funds have made net gains of 9.5% per annum against 9.8% for the FTSE All Share. So, not only are you making returns less than those of the index, you're also paying through the nose in hedge-fund fees. If you're going to charge high management fees and take a chunky proportion of the profits, "you'd better be a damned good investor", says Peter Dixon in The Business. But there's a common view in the City "that many of those who hired swanky West End offices and scraped together sufficient funds to call themselves a hedge fund aren't up to the job".