John Duffield’s recent departure from New Star Asset Management, combined with the closure of Jamie Allsopp’s Heart of Africa fund, has dealt a blow to the reputation of star fund managers. Nonetheless, Mick Killigan, head of advisers Killik and Co, says in the FT that if you find a good fund manager “you should stick with them”. But as markets have tumbled, so have many managed funds. So is good performance more about luck than skill?
Even a cynic such as Vanguard’s John Bogle – who has likened fund managers to lucky coin flippers – concedes that there are some worth investing with. Berkshire Hathaway’s Warren Buffett, for example. Or Invesco’s Neil Woodford. Having made 917% since 1990 against a 299% rise for the equity-income sector, his Invesco Perpetual Income fund is down just 11.6% this year against a 26.8% drop for the FTSE All-Share.
The trouble is that the likes of Woodford are a rare breed, as Jeffrey Busse, professor of Finance at Goizueta Business School in Atlanta Georgia, points out. He’s concluded that, over a 40-year period, 90% of a fund manager’s performance is largely down to chance. “There is a little bit of skill involved, such as picking the right sector to go into. But when it comes to picking the right stock in that sector, they’re not so good.” And when it comes to timing purchases and sales, they’re worse again, he says. In fact, “some are so big, they don’t even try to sell their stocks at the right time.”
And even if they get it right in the short-term, consistency over the long term is much harder to come by. A 2005 study by Morningstar Principia found that, between 1995 and 1999, top American fund managers were not able to reproduce their stellar performances again in the years from 2000 to 2004.
It’s bad enough that many fund managers underperform their benchmark, but worse still, they charge handsomely for doing so. Initial fees are often around 5%, with annual management fees typically 1%-2%. That’s not cheap, given that, according to Standard and Poor’s, over the five years ending June 2008, the S&P 500 outperformed 68.8% of actively managed large-cap funds. A simpler tracker or exchange-traded fund (ETF) may only meet, not beat, the performance of its benchmark index, but clearly that’s often better than what you can get from a fund manager. Better still, annual charges are typically well below 1%. For example, the Lyxor FTSE 100 (LON:L100) exchange-traded fund has a total expense ratio of 0.35% with no initial fee. So given that the chances of finding a Woodford or a Buffett are slim, you’re far more likely to end up better off if you just try to stick with cheap ETFs where possible.