Home Investing The Reality is that Almost All Actively Managed Equity Funds Underperform

The Reality is that Almost All Actively Managed Equity Funds Underperform


Are we about to see a shift in how Wealth Managers operate?

The quote in the title is not ours. It isn’t us casting doubt upon the value or quality of service that Wealth Managers deliver. It’s certainly a controversial statement and the supporting article published in The Times recently, contains a few other provocative perspectives. If you have a Times subscription take a look at this link to see what we mean.

If you can’t access the full article, the thrust of it is that Figures from S&P Dow Jones Indices show that almost nine out of ten UK active equity funds underperformed the benchmark over one year, with 86 per cent lagging the S&P United Kingdom BMI. It wasn’t even close. The average UK active fund declined by 3.8 per cent, whereas the index rose by 2.4 per cent. Investors would have done better to put their money in a passive fund, which replicates the performance of the index.

This sort of finding crops up again and again in measuring the performance of fund managers. Yes, it’s possible for active managers to consistently deliver superior risk-adjusted performance with good fundamental analysis of companies’ earnings prospects. But few do. And it’s a mathematical certainty that the average actively managed fund must underperform the average passive fund after costs. That’s because active funds employ people whereas passive funds instead use computer programmes to track the performance of an index. People are expensive; computer programmes largely have a one-off cost and are easy to amortize. Hence the fees for investing in a passive fund are much lower.

It’s hard to avoid concluding that the City isn’t meeting the needs of investors. And those who pay for that underperformance aren’t just rich people with large private portfolios. They are also life and pension funds with the responsibility of investing the regular contributions of retail savers and employees. They’re not getting a good deal. One problem is that asset managers have perverse incentives: they’re judged on short-term performance and this makes them averse to the risk of big losses relative to their competitors. So they tend to bunch in terms of their portfolio construction. They don’t differ much from each other in the sort of sector weightings they hold. Yet they still charge high fees, which the investors pay for.



What is the market response to these issues?

Asset management experts believe the findings will exacerbate investor concerns about overpriced, underperforming active funds, and will ultimately push investors into cheaper indexed and exchange traded funds.

Stewart Aldcroft, senior adviser on the Asian fund industry at Cititrust, the fund services business of Citigroup, said: “The S&P figures have become a massive boon for the ETF industry, which has been able to use them to show the benefit of passive investing. The active industry has built a whole range of arguments against [S&P’s statistics], but until they start to consistently achieve better returns, they will continue to be on the back foot.”

Assets managed in passive mutual funds, which provide lower-cost exposure to markets by tracking an index, have grown four times faster than traditional active products since 2007, according to Morningstar, the data provider. Assets held in passive mutual funds have grown 230 per cent globally, to $6tn, since 2007.

Dan Mannix, chief executive at RWC, the London-headquartered active fund house that is part-owned by Schroders, said: “These figures have to be worrying to fund managers who are essentially sitting on large amounts of assets and charging the wrong fees, and who are unable or unwilling to take the risks to try and outperform their indices.

“Investment managers as a community have to understand that we are in a dynamic industry and we have to invest in our capabilities in order to deliver something that is worth paying for.”


What does this mean for the Wealth Management industry?

You could argue that the Wealth Management industry doesn’t need to panic; there isn’t a “Kodak moment” on the horizon. Obviously not all Wealth Managers depend on simply pushing all their client’s money into funds, be they Mutual or any other sort; many offer a more balanced approach that includes discretionary or advisory services too. However, I don’t think it’s too controversial to say that actively managed funds as an investment vehicle are the core value proposition of the industry. If they simply offer a more balanced spread between actively managed funds versus ETF’s/passive funds, then could this perhaps accommodate the trend described above?

This is where I will be a little controversial and point to the quote from Dan Mannix above about fund managers being “unable or unwilling to take the risks to try and outperform their indices”. Surely that goal sits at the heart of every Wealth Manager’s operating values? The second part of Dan’s quote also points to the need for the industry to wake up to the need to change, “Investment managers as a community have to understand that we are in a dynamic industry and we have to invest in our capabilities in order to deliver something that is worth paying for.”

 The Wealth Management sector is a key part of that community that Dan is referring to; if the fund management sector isn’t meeting the needs of investors and needs to change, then wealth Managers as a prime conduit of monies into that market also need to respond.


What should Wealth Managers consider doing?

The key question for many must surely be, “how will I find a way to outperform the indices without taking huge risks with my client’s wealth?”

We all know that funds (whether actively or passively managed) offer lower risk than more discretionary or advisory investment approaches and have a lower demand in terms of time, effort and capabilities needed, so the right mix of actively managed and passively managed funds will inevitably continue to be a core element of most Wealth Managers offerings. But, we believe we will see more and more Wealth Managers develop the capability to help clients beat the indices by adding the ability to more dynamically invest in equities.


Why will the ability to generate equity investment ideas be a key component of a new service mix?

The answer to this question will alter a little over time as market conditions evolve but right now, especially out of the UK there are in our opinion only two viable forms of investment – equities and real estate. The bank of England’s interest rate stands at .25%, which has the knock on effect of making it very difficult to make any returns from fixed income – this may change in the future, as interest rates rise, however historically equities have always had better returns than real estate.

If we further consider real estate vs stocks, it’s clear that:

  • Equities are much more liquid and more diversified
  • Real estate ownership returns can be mimicked by purchasing publicly listed REITs. These have the benefit of having management in place and being significantly more liquid (such as Berkeley Group who pay a 6.5% dividend)
  • Equities are lower maintenance from the client’s POV

Let’s imagine that I am “Mr. X”, and I have just sold my business for £2m, or I am “Mrs. Y” who has inherited £500k. I know I need to invest this money, and I know there are lots of platforms out there which will help me do it. If I Google “buy mutual fund UK” I get 11.7m results. The top ones being companies like Barclays who have a platform of over 2,000 funds for me to invest in and choose right from my computer – and it only costs be 1 GBP a trade to buy.

Let’s say I am a savvy person and know that in the long run it is difficult for funds to return positive net returns, or at least if they do it is difficult to get the underlying data and really understand the figures. Therefore I want to build my own equity portfolio – I don’t know how to do this but I am happy to pay someone a fee for assisting me as this is a value added service.

I do a google search for Wealth Managers who provide tailored equity portfolios and there are not many (if any) positive hits – a lot of “bespoke solutions” but no one in the Wealth Management sector who really puts their hands up and says “yes this is us, we can help you do that”.

Increasingly we am convinced we will see more demand for this spread of service from the Wealth Management sector and whichever wealth managers start providing this first are going to have a huge first mover advantage in a relatively untapped market. I believe it is untapped for 2 reasons

  1. The traditional method is selling funds
  2. There has been no platform user friendly enough to assist Wealth managers in providing such a service (tools like Bloomberg are a bit scary and very expensive)

One of most costly assets a Wealth Manager has is time; the time to sit down and scan the news, read company reports, compile data, do the fundamental research, risk analysis……etc…etc – they are too busy looking after existing customers and finding new ones. Just finding the best equity buy ideas is an “art form” and time consuming; then researching and validating them before deciding where to invest your client’s money is time consuming work requiring the support of expensive market data services.

To feel confident that they can respond to changing demand, Wealth Managers need tools that are both simple to use with a short learning curve, and which can save them time while giving them the ability to offer their clients a service that differentiates them from those simply offering funds. It is also vital that such a solution delivers professional grade stock fundamentals to ensure their fiduciary duty to their clients is fulfilled

With the right tools, one day a week is more than enough to generate investment ideas and manage 3-4 model portfolios for clients and because fees are lower than buying into funds, the wealth Manager can generate higher margin income.

Change is coming to the Wealth Management industry because the market is shifting and clients are becoming more demanding. The “Kodak moment” will appear before we know it but those who can see it coming have a tremendous opportunity to change and bring clients the service mix they want for the market of tomorrow.


About the author

David Oak runs an investment research company based in Hong Kong which provides the equity investment rational to family office customers  and is now responsible for running their technology arm, Robur Investment Resources (www.roburir.com). “We designed and built the Robur Terminal to overcome the challenges in discovery and research of equity investment ideas and our dissatisfaction with the tools we used to use” says David.

The Robur Terminal is a cloud delivered platform that enables investment professionals to generate equity buy ideas in just a few clicks and professional grade fundamentals and analytics to validate selection. Robur also brings the consulting skills to develop bespoke variations in functionality and stock universe for clients as well as advising investment firms how to adapt to shifting market demand.

“We wanted a solution that was simple to use and shortened rather than over-engineered the process of generating buy ideas. With the Robur Terminal now we can generate buy suggestions for our portfolios in less than two minutes, a little longer if we want to apply stricter filters to the usual selection models; some of these come as standard, others you can customise to meet your own preferences. We can then perform the research and fundamental analysis we need to validate the ideas using our database that is maintained by our own dedicated data team.”

The Robur Terminal is unique in enabling Wealth Managers and other investment professionals to generate and research compelling buy ideas so quickly, simply and effectively. If you are interested in seeing how it could help your business, please go to www.roburir.com and see what it can do. You can get access to a free trial right away.

“We are now using The Robur Terminal to run our own investment business” says David “and generating stunning returns for our clients and profits for our firm and no longer use the expensive mainstream market data services we used to”.