Magazine article The Spectator

Trying to Pick Winners Is a Losers' Game

Magazine article The Spectator

Trying to Pick Winners Is a Losers' Game

Article excerpt

One dark evening in October 1994, I was standing in a small meeting room that faced on to Fleet Street, waiting for my last interview before I could escape into the rainy streets. Then a young trader strode in and asked me an unforgettably difficult question: why should Goldman Sachs - for that is where I had applied for a job - bother to spend money training a raw graduate like me to become an investment analyst when it could probably make better returns with a trading programme run by a computer?

In light of the awful performance of the investment management industry over the last year and a half, that question has particular pertinence today. It has been debated among finance professionals and academics for many years. Is it worth taking an active approach to investing and trying to beat the market? Or is it better to take a back seat and be content with the returns it provides?

The outlook for equity markets has recently improved, with both UK and US indices rising substantially since March.

This move out of the financial doldrums has tempted investors to dip a toe in the waters.

But the recovery is fragile and there remain huge doubts about the economic outlook. So those investors who are prepared to invest are going back to basics. And that means revisiting tough questions like the one I was asked in that small office so many years ago.

For retail investors, the safest active approach to managing your pension or savings is to spread your money around a number of fund managers, rather than trying to pick the stocks yourself. But advocates of passive investing say that it is not even worth trying to pick the right fund managers: it's better simply to invest in the equities market through a fund that tracks the index.

Gary Reynolds, director of the wealth management firm Courtiers, says: 'I very much favour passive over active investment.

Virtually all academic studies show that active mandates fail to beat passive mandates due to costs or additional risks.' Andrew Wilson, head of investment at Towry Law, agrees:

'Active managers have a poor track record, whether in equities or bonds. Even if they manage to generate higher returns than the market from time to time, they rarely manage to do so consistently, year in, year out.'

Statistics on recent market performance certainly support those views. The research firm Morningstar says that, on average, actively managed funds in the UK declined by 20.7 per cent over the past year, worse than the performance of the FTSE 100.

Hedge funds are the pinnacle of active management, aiming to generate higher returns than the market with the use of strategies that include going short, trading derivatives and using debt leverage. They are also able to invest across a wide range of markets, including commodities and foreign exchange. So if anyone can beat the market, it should be the hedge funds. But according to Research Affiliates, their performance was dismal in 2008, with returns sliding by 21 per cent - almost the same as traditional funds that are conservatively invested 60 per cent in equities and 40 per cent in the bond markets. Wilson says: 'The outlook for some hedge funds is much better this year than last year. But the hedge fund spell has been broken. Investors now understand that they cannot produce better returns than the market every year.'

The active management route also costs more than passive investing. Fund managers have to be paid to pick the right stocks and this is more expensive than setting up a fund that tracks an index through a computer programme. …

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