There are two basic but very different approaches to investing. The most common and least successful way is to invest in products that use active managers. The second, lesser used way, is the passive management approach which mimics an index or provides a broad market exposure.
Plenty of information supports the fact that the least successful way is still a popular approach. We now have new data further reinforcing how to invest and more importantly how not to invest.
Standard and Poor’s has been tracking the success of active managers for years. Active managers make ongoing investment decisions on behalf of their clients. Most Canadians hire them by purchasing the mutual funds that they manage. Within a mutual fund, the active manager decides what stocks to buy and sell and the timing of those transactions.
Mutual funds charge investors fees to delegate investment decisions to an expert, the mutual fund manager. However understandable it may seem to be, the outcome is most often less than favourable.
The science of investing has been studied and written about by the academic community for the last 50 years. The conclusion is that active managers only outperform the underlying market they invest in about one in every three years. When they outperform, the gains are lower than their shortfall during the years they under perform.
The academic research covers long periods of time. Standard and Poor’s reports the same information; however, they break it down into shorter time periods. They have just released their report for last year.
In 2012, 41 percent of active managers of Canadian Equity funds beat the S&P/TSX Composite Total Return. When we extend the holding period we see that only 10 percent of active managers beat the index over the past five years. In the United States 12 percent of managers beat the S&P 500 Total Return as measured in Canadian dollars during 2012. During the last five years only five percent outperformed the index.
The performance results for International Equity managers including all non-North American markets, was most surprising. Ninety-seven percent of managers beat the S&P EPAC LargeMidCap Total Return as measured in Canadian dollars.
That is the best one year number I have seen for active managers. Almost all managers added value for their clients by having better performance than the underlying market in which they invest. This outstanding one year performance is inconsistent with past results.
As it turned out the performance success was short lived. After virtually every manager beat the market last year, no managers outperformed the market for five years ending December 31, 2012.
Consider the Standard and Poor’s information as a report card for active managers. Active managers do not get a passing grade.
Canadians have approximately $800 billion invested in mutual funds and most are actively managed.
The Standard and Poor’s report summarized the performance by stating “The only consistent point we have observed over a five-year horizon is that a majority of active managers in most categories lag comparable benchmark indices.”
Investment decisions and their resulting performance are vitally important to our well-being. Our investment dollars help finance our children’s post-secondary education and our own retirement.
If active money management does not add value when comparing the performance results to the markets in which they invest, then why pay fees, commissions, trailer fees or any other form of cost to continue to invest this way?
Now is the time to answer that question and re-evaluate how you invest.