PERSONAL ACCOUNT

Nine in 10 funds are duds? It’s not quite as simple as it appears …

At first sight the evidence looked pretty damning: almost nine in 10 actively managed UK equity funds failed to beat the index last year. It would be understandable if investors who read the headline simply sold all their active funds and reinvested the money in the cheapest tracker they could find.

I don’t for a moment think this would be a disastrous course of action, as long as the indices to be tracked were chosen with some care. But I think it’s worth delving a bit deeper before ditching actively managed funds altogether.

There are several aspects of the question that should be considered.

First there is the matter of time scale. One year is a very short period of performance on which to base a decision about your investment strategy. The research, from S&P Dow Jones Indices, also looked at three, five and 10-year periods, where the results were not so damning for active funds.

Over three years about 40pc of UK equity funds outperformed the chosen index, which was the S&P United Kingdom rather than one of the FTSE indices. Over five years half of them managed it, while over 10 years the figure was back down at about a quarter.

Given that is it (virtually) impossible for all funds to beat the index, and the widely known presence of many dud and expensive funds among those included in the research, these percentages do not strike me as particularly bad.

Even the most ardent fans of active management accept that you will get outperformance of the index only if you put quite a lot of work into fund selection; if, say, more than half of funds beat the index it would imply that the task was simpler than it actually is.

Then there is the matter of the state of the market at the time you invest. We have just experienced eight or so years of a bull market fuelled by an ample supply of cheap money from central banks. At such times you often see all stocks, good or bad, rising together, weakening the case for active management.

So in 2009, when the FTSE 100 and other indices hit their lowest level of the financial crisis, it would have made good sense to choose trackers rather than active funds.

This is hindsight, you might say, but the market was cheap then on objective measures. Now it is much less so: indeed, when current valuations are considered alongside the slow rate of profit growth and the various headwinds we can expect, I’d say a static or gently rising market is more likely at this stage. We really cannot expect the next eight years to be as buoyant for shares as the last.

If I am right, anyone who buys a tracker now would get that same lacklustre performance, whereas for me a well chosen manager who is able to find reasonably valued shares in firms that are managing to grow their earnings would be the better bet.

One figure in the research that I did find surprising was the poor record of actively managed global funds. Only 1.5pc of them managed to outperform the relevant index over 10 years (the figures for one, three and five years were 11.5pc, 9.5pc and 2pc respectively).

These figures seem to tilt the chances of finding a fund that can outperform too far in the wrong direction and here the arguments for a tracker seem stronger.

One can speculate that global equity managers find the task of selecting, say, 50 companies to invest in from the thousands available across the globe overwhelming.

The other point in favour of buying global tracker funds is that if you don’t believe in trying to pick winning shares in any particular market it makes sense to apply the same logic to countries and simply invest in them all.

Ultimately though, I think it’s wrong to see trackers and active funds as an either/or choice. My own portfolio contains both: my company pension is in low-cost trackers while my self-invested pension currently consists entirely of actively managed funds.

And the balance between the two types is sure to change in future: if a favourite fund manager retires I may decide to put the money in a tracker; as valuations evolve so too will my portfolio breakdown.

It’s a fascinating debate, and one that can only make us better investors.

‘Tracker’ funds often outperform their actively managed rivals