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Everybody knows that fund managers generally aren’t very good at their jobs.
Most of them rarely manage to outperform whatever benchmarks they are being measured against, let alone make their clients money over a prolonged period of time. Evidence shows that in the long term, simple tracker funds outperform actively managed funds about 75% of the time.
And as we often point out at MoneyWeek, being a successful investor mostly relies on being in the right sectors at the right time, rather than picking stocks.
So it wasn’t much of a surprise to us to read Tom Stevenson’s piece in The Telegraph about a Dresdner Kleinwort survey which suggests that straightforward rule-based models tend to outperform human judgement in nearly 100% of cases, across a whole range of situations.
So why are fund managers, and people in general, so poor at their jobs – and more importantly, how can ordinary investors avoid making the same mistakes?
Behavioural strategist James Montier of Dresdner Kleinwort studied 136 different situations where mechanistic decision-making models – in other words, those which used the same assumptions and same rules in every case – were pitted against the judgement of human experts.
The human beings outperformed the models in just eight cases, and in each of those, the humans had the advantage of added information. On average, the models made the right choices 73% of the time, while human experts only managed 66%.
The humans even underperformed when given the results of the models before they made their own decision. Montier concludes that “the evidence is clear: quantitative models usually provide a ceiling from which we detract performance rather than a floor on which we can build.”
As Stevenson points out: “You won’t find a fund manager who doesn’t use some sort of screening approach to produce a shortlist of possible investments, but he nearly always overlays his own judgement to make the final selection. Which would be fine were it not for the fact that, at best, this human intervention adds nothing.”
But fund managers shouldn’t feel too bad – they aren’t the only professionals whose rampant self-belief results in them making poorer decisions than anyone with the basic ability to follow a simple flowchart. Psychologists have been studying this for years, and the phenomenon holds true for everything from medical diagnoses to court cases.
In fact, we all suffer from the same problems. We tend to overestimate our abilities. Most of us can easily bring to mind our investment triumphs – but all those decisions that weren’t quite as clever (or lucky) tend to get pushed to the back of our minds.
So what does this mean for investors? Well, for one thing, if the vast majority of fund managers don’t add any value to a portfolio, then why pay them all that commission? You’d be far better off managing your own investments – at worst, you’ll get the same level of incompetence, but without the annual fees.
The next point is on choosing stocks. If the majority of returns come from choosing the right sector or market, then perhaps you’re better off avoiding those tips you get from the bloke down the pub. Exchange-traded funds are a great way to get exposure to a wide range of investment areas, from commodities to a variety of emerging markets. To read more about ETFs, click here: Forget funds – it’s picking markets that matters (/file/15784/forget-funds—its-picking-markets-that-matters.html)
MoneyWeek magazine gives a regular rundown on the sectors and assets we believe people should be buying right now – as well as those you should avoid. If you’re not yet a subscriber, you can get access to all the content on the MoneyWeek website and sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a three-week free trial of MoneyWeek. (/file/194/subscribe-from-not-logged-in.html)
And here’s somewhere else that you might pick up a few interesting tips…
Complimentary Admission to The World Money Show London
MoneyWeek invites you to attend – for free – the most comprehensive private investor and trader education event – The World Money Show London, 29-30 September 2006, at the Queen Elizabeth II Conference Centre.
Your free admission will provide you with access to more than 50 educational events and representatives from more than 80 top financial companies in the International Exhibition Hall. To register for FREE admission, call 00 800 1414 8888 (international free phone) between 10:30 – 22:30 BST (mention priority code #006795), or register online at:
https://worldmoneyshowlondon.co.uk/main.asp?scode=006795
We’re sure even the most experienced investors will find the conference very useful. And did we mention it’s free?
Turning to the stock markets…
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After a slide earlier in the day led by commodities stocks, a strong start on Wall Street pushed the FTSE 100 back up to close 27 points higher at 5,897. The biggest faller was Cairn Energy, down over 2% as the price of oil fell by nearly a dollar. Miners Rio Tinto, Xstrata and BHP Billiton were also among the losers after Lehman Brothers issued a mixed note, whereas Intercontinental Hotels rose 1.77% on positive broker comments. The biggest rise of the day was Reuters Group, up 2.71% to £3.88 a share. For a full market report, see: London market close
European stocks were also boosted by the positive start in the US. The Paris Cac-40 climbed 68 points to close at 5,115. And in Frankfurt, the Dax-30 closed 84 points higher at 5,776. The biggest gains of the day were made by energy supplier RWE which rose over 3% on bid speculation over the sale of its subsidiary Thames Water.
On Wall Street, a lower-than-expected inflation report – which eased fears of another interest hike in the near future – sent stocks surging. The Nasdaq climbed 45 points to a one-month high of 2,115. The Dow Jones rose 132 points to 11,230, its biggest one-day rise in six weeks, whilst the S&P 500 closed 17 points higher at 1,285, its highest level since the start of June.
And in Asia, the Nikkei 225 rose above 16,000 for the first time since May 19, closing at 16,071.
The price of US crude oil continues to fall, trading 10c lower at $72.95 in New York this morning. In London, Brent spot was at $73.50 a barrel.
Japanese speculation saw spot gold trading at $624.50 this morning, having fallen slightly from an intraday high of $626.60. Buying interest from jewellers and the industrial sector also sent silver up to $12.08 late in New York.
It has come to light that shareholders are filing a lawsuit against top BP executives following the shutdown of part of the Prudhoe Bay oilfield. The defendants are seeking compensation for BP’s alleged failure to maintain pipelines adequately. There has as yet been no comment on the matter from BP.And nuclear power generator British Energy announced a 145% increase in Q1 earnings this morning, as higher electricity prices boosted revenues.
And our two recommended articles for today…
Why Helen Green’s £800,000 isn’t as much as it seems
– There has been plenty of criticism surrounding the £800,000 payout award to former Deutsche Bank employee Helen Green. But, says MoneyWeek editor Merryn Somerset-Webb, do the numbers properly and instead of wondering if she got too much, you might wonder whether she got enough. For more on the best ways to invest a lump sum – and how to calculate the likely income – see: Why Helen Green’s £800,000 isn’t as much as it seems
Where to invest as silver heads higher
– MoneyWeek has long been bullish on silver, first putting it on the cover back in March 2004. Since then, the price of silver has more than doubled. So we put it on the cover again recently. To find out why silver is set to head even higher – and the four best ways for you to invest in the metal – read this MoneyWeek article (just available to non-subscribers): Where to invest as silver heads higher