Can Investors and Investment Managers ‘beat’ the Market?

At its core, the investment industry is clearly divided into two camps. On one side you have the active investment managers, who are still in the majority, and believe through research, market timing and smart decisions, they can beat the Beat_the_Marketmarket and give their clients superior returns. On the other side you have passive investment houses who promote Index Tracking and Exchange Traded Funds. The passive camp believes you cannot beat the wider market and therefore just achieving a return as close as possible to the market return is a success.

The passive camp generally has significantly lower fees and tends to be lower profile with a less ‘flashy’ brand.  Active investments managers are generally very well known, very well paid and sell an attractive back story of past returns and performance.

For the record, I’m firmly in the passive camp, although with some reservations!

It would be easy to do a PHD on the relative merits of active versus passive investment management given the amount of data, research and opinions on the subject. However, the simple data can be assessed by just looking at a few telling charts. I have used UK data here as the sample is much larger than the Irish market, but the information for Ireland very similar.

The first chart shows the S&P500 when compared to the average UK North American Equity Fund, going back to 1990. The S&P gained 647% over the period, with the average fund gaining 508%.

Graph 1

I could run any number of charts which will show a similar story to the above, with the indices easily beating the average investment manager over most time frames.

A similar story is the case for more local investments, such as the UK FTSE All Share Index, with the index outperforming the average manager by almost 100% over the same 23 year period.

Graph 2

Obviously, I’m only using the average here and there are investment managers who beat the market over short time frames. The difficulty is identifying which manager will beat the market next year. That is almost impossible and has no correlation to their past performance. Over time, almost all investment managers revert to the mean market performance, less their fees, and hence the average underperformance.

It is hard for investors to ‘un-learn’ their belief that their money should be managed by the highly paid fund manager in an expensive office, and trust their money to the markets without much intervention. However, an overwhelming weight of evidence would suggest that this is the more successful strategy.

My belief is that investors should look beyond the existing ‘market capitalisation’ weighting ETF’s and index tracking funds to recently developed ‘smart beta’ type investment vehicles which combine the low cost passive approach mentioned above, with some consideration for value and asset allocation.

For more information on passive investing, smart beta and how to access these investment vehicles drop me a line.

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