When I began my career in the investment industry, the thought of investing in a fund which guaranteed to do slightly less well than the index was an absolute anathema.
One of the larger UK insurance companies at that time employed two fund managers who decided the best way to use their time efficiently was to divide up the shares in the portfolio on an alphabetical basis. I’m not joking, this really happened.
Also, more than 40% of shares were then owned directly by private investors, most of whom had little knowledge about how to value shares or access to quality information other than what they read in the papers or overheard at the golf club.
Around this time a young Cambridge engineer called Anthony Bolton was embarking on fund management. Not surprisingly, this intelligent and diligent young man performed very well compared with the market and so did a number of others who were similarly professional.
However, without wanting to take away anything at all from their achievements, the fact is that most of the competition was rubbish. So it made no sense to buy a tracker when there was a reasonable chance that with good research you could find an active manager that would do much better.
Fast forward 37 years: markets now trade globally round the clock, information is available within nano seconds of release and computers use complex algorithms to exploit minute pricing anomalies.
The performance of institutional managers is scrutinised intently and those that fail the test are quickly dropped.
Rewards are high so the profession attracts some of the brightest candidates and none of them believe that the name of a company is the most logical starting point for analysing it!
In these conditions it’s not surprising that most active fund managers fail to beat the index over the long term (after costs).
This has changed my view on fund selection and my default choice for large stocks in major markets is now a passive fund.
It no longer seems defeatist to accept the certainty of slightly below market returns.
When I do invest in an active fund I expect it to be really active. I don’t mean high turnover – that’s usually wasteful – but I want the manager to make punchy bets to justify the higher fees.
Closet trackers are the worst of all worlds, offering higher costs and virtually nil prospect of significant outperformance.
John Spiers founded Bestinvest in 1986 and served as chief executive officer until June 2010, overseeing its £165 million acquisition by 3i in 2007.
Prior to founding Bestinvest he worked for stockbroking firm W.Greenwell.