Would you drive down a road you had never seen before, looking only in the rear-view mirror? No, me neither. Now, how about trusting the car's autopilot or algorithms to get you there in one piece? Well, maybe one day but not yet.
That pretty much sums up my feelings about passively-managed tracker funds, which are back in the news following Febrile February’s flash crash on global stock markets. Exchange traded funds (ETFs) and, more specifically, inverse-leveraged exchange traded products (ETPs), are being blamed by some for sharp fluctuations in selling and buying as algorithm spoke unto algorithm, temporarily drowning out human traders’ voices in a digital tower of Babel, driving share prices sharply down and then partially back up.
It will be interesting to see how this round-trip affects tracker fund returns. As a long-term investment trust shareholder, I have often been a bit puzzled by the ferocity of some passive funds’ devotees when defending this form of asset allocation and attacking the high costs of active stock-selection.
Is this what people mean when they talk about being ‘passive aggressive’? I only ask because, unacknowledged by the tracker fans, low-cost active stock selection has been available for 150 years via investment trusts.
Now here comes fresh analysis (Winterflood had similar figures in December) showing that nearly two thirds – or 64% to be precise – of investment trusts beat their benchmark over the last five years. The proportion of investment trusts that outperformed their chosen index increased to more than three quarters among UK smaller companies, Japan, UK equity income, Emerging Market country funds and European sub-sectors.
The analysis by Canaccord Genuity is less reassuring for shareholders in the Global sector, where fewer than one in five funds beat their benchmark, or US blue chips, where the proportion of professional fund managers who carried their weight was nearer one in 10.
Analyst Alan Brierley commented: ‘In recent years, the inability of active managers to beat benchmarks has been a driver of the seemingly inexorable rise of passive management.
‘The S&P SPIVA – or active versus passive comparisons – have sobering data on this. For sterling-based funds they found that over five years, while just over half of UK funds outperformed, just 17% of Global and 10% of US large-cap active funds were ahead of benchmarks.
‘Over 10 years, even fewer active managers had added alpha, with just 6% of Global and US large-cap funds outperforming.’
This research tends to confirm my belief that active stock selection is most likely to add value in under-researched sectors. That’s where accurate information and intelligent analysis on a stock-specific and timely basis can give investors the edge ahead of the crowd.
It also confirms my suspicion that many self-appointed champions of low-cost ETFs and other types of tracker funds are either unaware of – or wilfully ignoring – the most long-established form of low-cost pooled fund available to individual investors; that is, the tried-and-tested investment trust.
I should emphasise that, unlike some who routinely accuse anyone who disagrees with them of dishonesty or concealed pecuniary motives, I believe there is plenty of room for both strategies. Two views make a market.
Tracker funds have their place for people who do not wish to take much interest in where their money is invested or bother with the additional risk of choosing the right fund manager. This group may even constitute the majority because most folk claim to find money a dull topic, although quite why that should be has always mystified me.
But investment trusts can – and often do – maximise returns and minimise risks for shareholders willing to do their own homework and look beyond the latest financial fashions.
Here is a complete list of Ian Cowie’s stock market investments. It is not financial advice nor is any recommendation implied.