IMAGINE you’re an investment pro at one of the UK’s big asset managers. You’ve been doing this for 20 years, made many hundreds of company visits and listened to thousands of brokers’ calls.
You might have an MBA (21 months, £115,000) or even gone full Chartered Financial Analyst or CFA (minimum 300 hours of study per level, pass rate 40%). You know your z-scores from your r-squared.
Now imagine that your professionally run portfolio just got outperformed by a 24-year-old with none of your credentials or barely an inkling of how a price-earnings ratio works, let alone the ability to calculate a discounted cash-flow model.
That’s what just happened to a large group of UK fund managers. In the first quarter of 2024, the Investment Association (IA) Mixed Investment 40%-85% sector – a reasonable benchmark with retail investors given its mixture of bonds, equities and cash – rose 4.2%.
The average portfolio held by 18 to 24-year-olds at Interactive Investor, one of the UK’s retail investment platforms, rose 5.1%. Review the performance of all customers over two and three years and, assuming you’re a fund manager, you’ll see something equally depressing.
The amateurs have returned 6.8% and 12.8%, respectively. The pros have returned 10.7% and 5%. Things don’t look quite so awful if you compare the pros against all Interactive Investor customers (4% versus 4.15%) or extend the time frame a bit: Since January 2020, fund managers have performed a smidge better than the amateurs (18.7% versus 18.4%).
There’s much to quibble with here. Is the IA Mixed the right comparison? Would this hold over a longer period (the private investor index has only existed for four years)? And what about all the expenses fund managers have that private investors don’t?
But look at the bare numbers here and it’s hard to argue that unless you simply can’t be bothered to engage with investing, hiring a guy with a CFA to oversee your money is worth the bother.
And that’s before we even get to the fact that very few of those hardworking super-qualified managers have been able to beat a portfolio of passive investments over the last few decades either.
This failure hasn’t gone unnoticed. At first glance, the global fund management industry might look to be in rude health. As a report from Boston Consulting Group Inc (BCG) notes, total assets under management rose 12% in 2023 to US$120 trillion.
But this rise masks an underlying vulnerability: That same year costs rose 4.3% and revenue by just 0.2% as most inflows went to cheap passive funds (70% globally with the majority of US-domiciled funds now managed passively); the average fees investors are prepared to pay just kept falling; and attempts to launch new products have flopped — consider the grand marketing effort that was environmental, social and governance!
Only 37% of all the mutual funds launched in 2013 still existed in 2023. Overall profits fell by 8.1%.
Not so rude after all. A lot of firms have been saved by the money from consistently rising markets, the biggest driver of rising assets under management. But hoping markets keep going up is hardly an innovative business model. It certainly hasn’t been effective for UK fund managers.
So what’s an asset manager to do? BCG thinks it has the answer: artificial intelligence (AI). Sounds great. No one is likely to complain about handing off the relentless box-ticking that comprises much of what counts as running a modern business – with the added bonus of slashing costs.
But there’s something else to think about: the opposite of AI, actual active investing. The last decade has been especially awful in this area. Yet the hit rate of active versus passive is more cyclical that you might think. It’s outperformed for long periods – the mid-1960s and the late 70s and for much of the time from 2001 to 2011, says Waverton Investment Management – and those outperforming periods have also often followed those of intense market concentration (like the one we’re in now).
But the key word is active – which an awful lot of apparently active funds still aren’t.
Waverton has had a skim through some of its competitors’ balanced active funds and found that many, while promising active management, actually have well over 10,000 underlying holdings – something that makes them effectively passive investments.
This is “active washing” – or as it used to be called, closet tracking. It matters, and it’s all about benchmarks. Look at most active funds and you’ll find their top holdings aren’t that different from those of their index; that the active share (the extent to which their holdings are different from those in the index they’re judged against) isn’t high enough; and that they have too many holdings for you to be confident of their conviction in any of those holdings.
The private investors on UK platforms don’t have this problem. They care nothing for benchmarks – and everything for preserving and growing capital in absolute terms. Fund managers might do well to think more like them:
Go for real active and advertise it as such. This doesn’t mean going full YOLO (the 18-to-24 group outperformed by holding investment trusts trading on large discounts).
Nor does it mean that retail investor tactics can be easily transferred to the industry. It does mean dumping benchmarks, focusing on absolute returns and accepting that for real success to be possible, failure is also possible. That’s a product that might sell – and one I would buy. — Bloomberg
Merryn Somerset Webb is a Bloomberg Opinion columnist. The views expressed here are the writer’s own.
