The mounting evidence against fund managers

The idea that active fund managers can beat the market by anything other than luck doesn't stack up. Here's yet more proof.

I've written here several times about the possibility that there is more luck than skill involved in fund management. Further evidence comes from a piece in the FTrunning through a bit of research from Fitch on the performance of emerging market debt funds.

It turns out that they are on the whole "spectacularly unsuccessful" at outperforming any given index. Or even at matching that index. Fitch looked at the 25% of funds which had the best performance record in the period from 2006-8 (ie, that were in the top quartile) and looked to see what happened next.

The answer? Nothing good. In the subsequent three-years, 88% of them ended up in the bottom quartile. At the same time, 72% of those in the bottom quartile jumped to the top.

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Overall, a mere 10.5% of the funds managed to deliver top quartile performance for both periods. This is pretty pathetic stuff: even if you were to assume that performance was entirely random, that number would be 25%.

There is some explanation in the point that the two periods required different styles of management: in the first returns were all about domestic inflation and growth, and in the second, they were more about global crisis.

But that explanation hardly provides an excuse: the reason active fund managers get paid is because they have sold the idea that they are capable of doing better than the market as a whole under any conditions not just under the one set of conditions that by lucky happenstance fit their management bias.

Fitch suggests that it is possible foremerging marketdebt managers to "evolve" and proposes ways in which they might do this (they could, for example, "broaden their macro research horizons").

But I wonder if what we are seeing here is not just further proof that successful short to medium term investing is driven by momentum. As I said in this column earlier this year on the subject of equity investing, "managers who do well tend to have a style that works in a particular market. The skill bit is being good at that style. But style is only of use if market momentum is working with it which makes luck the most important bit".

The bond market is no different. If you must buy intoemerging market debt, do yourself a favour and buy an exchange-traded fund (ETF) instead. These only account for 3% of theemergingdebt market at the moment. Clearly they should account for a lot more.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.