‘Things that there are too many of’. It’s a long list, but if you turn your thoughts to the financial industry, you will see that the standout is investment funds.
I have no idea how many funds there actually are available to chip away at your savings in the UK, but you can choose between over 2,000 at the top fund supermarkets alone. On that basis, I would guess at 7,000-10,000 in total. Most of those will be rubbish in one way or another, which of course is why the average active fund regularly underperforms any given index.
So here’s an interesting thing to wonder about at the beach this year: what if a 20-year bear market meant none of the big houses bothered to market funds in one particular sector any more? What if they also closed down a good few of the funds in that sector? And what if all the managers not dedicated to it, or for that matter not much good at it, chucked in institutional money manipulation and retired or wandered off to become buy-to-let landlords in the UK instead?
Might you then be left with a hard core of good funds run by clever people who know their market and can prove once and for all that it is possible for active fund managers to consistently outperform? Darwinism in action.
This might sound like crazy talk, but a report just out from Simon Evans-Cook of Premier Multi-Asset Funds suggests that this is exactly what has happened in Japan. I asked a couple of cynical wealth managers this week how they thought the average UK fund investing in Japan had performed relative to the index recently. They guessed, as expected, that it had underperformed. But, according to Mr Evans-Cook, they are completely wrong. In fact, the average fund (as judged by a weighted index) has returned an annualised 6.1% over the past five years and has beaten the index (the FTSE Japan) impressively – by 9.9%.
Clearly, investors in some other countries are losing out to UK investors, since the average of all funds everywhere has to underperform thanks to the effect of costs. But as Mr Evans-Cook notes, “for UK investors, active management of Japanese equities has been worth paying for”. He puts this down to Darwinism and to the smaller size of today’s Japan funds – work in a bear market long enough and you always end up with a small fund.
It’s also because the long bear market has created an “understandable bias” to value investing among UK fund managers looking for holdings in Japan, and value investing is the strategy that has the best record of working over the long term in any market, including Japan. Take this market in isolation and you could, should you fancy it, claim that it tells us that good active fund management works. So investing is just about finding a good fund manager. No more, no less.
Naysayers will say that it tells us nothing of the sort. Instead it tells us that the Japanese market is still jammed with zombie companies that only a zombie manager would buy. Anyone who doesn’t buy them will outperform the index. It could also tell us that as foreigners are really the only net buyers of Japan, it is obvious that the stocks they like, or at least understand, will outperform the others – in Japan, you could say that lazy fund managers effectively create their own outperformance.
Add it all up, and as one ex-manager pointed out to me this week, only a fool could underperform the Japanese market as a whole.
This might be entirely true, but as I pointed out to him, there were clearly a lot of fools working in the Japanese market in the 1980s when the Nikkei soared to 39,000. Either way, I think the point is made. In most markets, thanks at least in part to the fools, it is easier (and often kinder to your savings) to choose a passive fund over an active fund. In Japan, if you are investing from the UK at least, the opposite is true.
This brings me to an area where Darwinism has been markedly absent for some time – emerging markets. Here, the new launches have been coming thick and fast for years. Asian income funds, consumer spending funds, property funds. You name it, someone’s launched it. Those someones will include some fools and some very smart people. I haven’t got numbers for their relative performance, but my guess is that right now, neither group will be particularly happy. The MSCI Emerging Markets index has disappointed horribly recently, and is down another 10% this year so far.
The good news is that these falls are finally shifting stocks back to the right price. In 2007, the emerging markets as a whole traded on a very silly cyclically adjusted price/earnings ratio (cape) of over 30 times. Now that number is 13 times (the US is currently on about 24 times). Prices might well go lower, but at these levels they are getting interesting. I’ve been avoiding emerging markets for ages but I think it is time to buy again – in a small way for now.
First State’s Global Emerging Market fund has a better record than most. If there were a 20-year bear market, their managers would still be standing at the end. First State is imposing a 4% initial charge on investors from September in an effort to limit the size of the fund, so if you are thinking of buying, do so now.
If you want an investment trust, you might look at Genesis Emerging Markets Fund which trades on a 9% discount to its net asset value.
• This article was first published in the Financial Times.