At MoneyWeek, we tend to favour passive funds (those which track an index rather than using a manager to stockpick). They are cheaper than active funds, and you can be fairly confident that they’ll at least track the market you are investing in. Active managers sometimes outperform by enough to justify their fees, but finding one that can do it consistently is the tough part.
However, might it be better to look at a ‘smart beta’ fund that follows a set of rules, rather than a specific market index? Research from Cass Business School suggests it might.
It took monthly US share data from 1968 to 2011 and had a computer randomly pick and weigh each of the 1,000 stocks in the sample. In effect, as the co-author, Professor Andrew Clare, notes, this is handing over stock-picking to a monkey.
Incredibly, they found that nearly all the resulting ten million methods of constructing an index “delivered vastly superior returns” to the market capitalisation approach (where stocks are picked on the basis of their size measured by the number of shares they have issued, multiplied by the current share price).
In other words, you’d be better off looking for a passive fund that uses a different set of rules to choose its shares from the traditional indices.
One example is the Powershares FTSE RAFI US 1,000 Portfolio (US: PRF). This exchange-traded fund (ETF) tracks an index of 1,000 shares chosen using a ‘fundamental’ approach that selects shares according to four criteria – book value, cash flow, sales, and dividends.
The ETF, which charges 0.43% a year, is up 6.79% a year over the last five years, compared to 4.99% for the US benchmark index, the S&P 500.