You could be forgiven for thinking that active fund managers have been having a hard time of it lately.
First there was the release of the 2016 results of the independent scorecard produced by research and ratings group S&P Dow Jones that tracks how active managers are performing versus index.
The SPIVA scorecard result did not make for happy reading with the majority of active managers across all the major asset classes underperforming their respective benchmarks.
Perhaps the most telling result was that over the 10-year period to December last year, 70 per cent of Australian equity, international equity, bond funds and REITS underperformed their respective benchmarks.
S&P Dow Jones have been producing the SPIVA scorecard for 15 years and do not see any discernible trend or pattern in the one-year results. Some years active managers outperform, some years they underperform. What S&P Dow Jones do discern though is that over the longer time periods – 5, 7 and 10 years – most active managers struggle to beat the relevant market index.
While the SPIVA report is generally read and debated by industry insiders, when Warren Buffett – arguably the world’s best known investor – weighs in, the discussion gets a lot more mainstream media commentary and investor attention.
Buffett, writing in his much anticipated annual chairman’s letter to Berkshire Hathaway shareholders says: “When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsize profits, not the clients. Both large and small investors should stick with low cost index funds.”
In doing so he referenced his long-running bet with a hedge fund manager – Protege Partners– that is in its final year where Buffett wagered that $500,000 invested in the Vanguard S&P500 index fund over 10 years would outperform a selection of five hedge funds – after fees and expenses.
The results to the end of 2016 have the S&P index fund having an annual increase of 7.1 percent while the five funds-of funds have delivered 2.2 percent. Buffett makes the point that $500,000 invested in the hedge funds would have gained $220,000 versus $854,000 for the index fund.
Buffett gave a shout out to Vanguard’s founder Jack Bogle who he says “has helped millions of investors realise far better returns on their savings than they would otherwise have earned”.
The irony in all of this commentary from Buffett is that, of course, he has earned his worldwide reputation as an investor by taking an active approach. So for the millions of investors following his advice it is a case of do as I say, not as I do.
While the SPIVA scorecard is a useful measure of active managers’ promises of outperformance, in context it does not attempt to answer the fundamental question it poses – why do the majority of active managers underperform?
Can it simply be bad investment decision making? It is a professional, competitive industry after all.
Amidst all the clamour about active versus indexing one issue is often overlooked: costs.
If you read Warren Buffett’s critique it was as much about high fees that investment firms charge investors as it was about the challenge of active management outperforming.
That speaks to what is cause and what is effect. High fees simply make a hard task – outperforming markets over the long term – that much harder, if not impossible for many active managers to achieve.
For investors, the task is arguably even more difficult: identify the next Warren Buffett before he has gained global icon status.
That is like trying to find the needle in the proverbial haystack. Which is why, as Jack Bogle often says, it is better to buy the haystack, which broad-based index funds do very effectively at low cost.
Written by Robin Bowerman, Head of Market Strategy and Communications at Vanguard.