IFA ACTIVE FUNDS HAVE A 3% CHANCE OF OUTPERFORMING FIVE YEARS IN A ROW. Tracker or active debate generates fascinating debate, and goes to the core of an IFA offering. While IFAs are not stock pickers, we study trends and follow funds and collectives and advise accordingly. Models are based on broad brush strokes.
The relative performance of active funds has been under scrutiny since the FCA first indicated that they did not believe that actives added sufficient value – way back in 2016. Many funds that the regulator looked at did not outperform their benchmark after fees.
The Investment Association reacted by calling the study flawed. Nearly a decade later, with active fund managers struggling on all fronts, this comment is worth examining.
Only a minority of funds outperform the average. But that statistic is trivial, called out one article in the FT. The case for indexers is outlined neatly by their text below:
“As market pricing is driven by the collective actions of stockpickers, statistically half must underperform in any given year. Just like not everybody can be taller than the average; only half will be. After 2 years – if everything is random, 25% will outperform, after 3 years 12.5% and so forth. So obviously, over long stretches of time very few will outperform. Which is precisely the reason to invest in an index fund as opposed to ‘betting’ on which fund manager will be lucky to produce a lengthy stretch of outperformance, and paying a 1-2% annual fee for holding on to that bet…
“The chance of outperforming an index repeatedly year after year is 0.5 to the power of n, where n is the number of years. Take the chance of outperforming five years in a row and you come to the absurdly low number of 3%….”
The case against index tracking.
Outperforming over any arbitrary stretch of time has a 50% chance, regardless of whether it’s 1 year or 10 years or whatever. Indexers also have costs, and are bound to lag behind the average.
“By definition, all or a majority of investors cannot outperform the market (the market is just the aggregate of those investors). So for every outperformer there has to be a loser…”
Facts give you Efficiency, accuracy, and strategic advantage. Use BAT.