Fake News - Active outperforms Passive

Unfortunately we now live in a world of fake news and ‘alternative facts’ where parties shamelessly push their own agenda and narrative at the cost of salient facts.

In order to be heard in the noise of social media, research headlines need to be bigger and more eye-catching.

For those investors using an evidence-based approach that means it is important to make sure that any evidence being reviewed is based on true facts, reliable data and sound research methodologies.

There is much good research and empirical evidence available, but some of a lesser quality occasionally makes the headlines.

A recent piece of research by a fund management firm that manages over US $580 billion is a case in point, making the statement:

‘Active funds beat passives in every market in the UK over a 20-year period.'

That is quite a claim to make.

The firm looked at funds in seven categories using the services of Lipper, the American fund performance research firm, and – somewhat surprisingly for an investment house filled with bright and talented people - compared how the fund with the best performance over the past 20-years had done relative to passive alternatives (index funds) and the index.

The methodology is so evidently flawed as to hardly be worth reviewing. It is best summarised as requiring a fund-picking strategy of perfect 20-20 hindsight!

They concluded that it would have been worth identifying the best active fund instead of using a passive fund.

The problem is that this is almost impossible to do.

Alan Miller of SCM Direct – a firm which has campaigned to improve investor outcomes – summed it up most effectively:

‘It's a bit like saying you're better off buying a lottery ticket than putting your money in the bank because had you won the lottery each year, you'd have done much better.’

Unfortunately this type of naïve research risks misleading retail investors, and even some advisers, against a sensible evidence-based approach.

In their own data, the fund management firm in question revealed that in the six Lipper categories where there was a passive fund with a 20-year track record, in five categories, the average passive fund beat the average active fund.

In the sixth category, there was nothing much in it.

The best passive fund – which you do have a fair chance of identifying, unlike an active fund – outperformed in all six categories.

Another methodological flaw arises; no account seems to have been taken of the high proportion of UK-based funds that would have failed to survive the period.

A reputable study reveals that only around 50% of sterling denominated funds survived the 10-year period to the end of 2022.

Over 20-years this figure is likely to have been even worse.

We also know from this study that, on average across the eight categories of funds denominated in sterling (so a similar fund set to the flawed research above), 80% of active funds failed to deliver on their promise of beating their market benchmark over 10-years.

For a 20-year period this is likely to be higher, as evidenced in the US version of this study.

All I can say is, ‘Enough, already!’ as our American friends might say.

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