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 FT running 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.
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 for emerging market debt 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 into emerging market debt, do yourself a favour and buy an exchange-traded fund (ETF) instead. These only account for 3% of the emerging debt market at the moment. Clearly they should account for a lot more.