Kernel's Dean Anderson, who manages index funds, takes a critical look at the performance of his rivals, active fund managers, as everyone battles through the markets in a pandemic

This is a repost of an article by Kernel, an index investing platform. It is here with permission.

Opinion

Warren Buffett famously said that “when the tide goes out, you’ll see who’s been swimming naked”. Right now, active fund managers are high and dry.

Active fund managers have long defended their high fees and underperformance by stating their value will be proven in the event of a correction or crash. You see, active managers claim their research and close scrutiny of the market equips them with the foresight to shift portfolios appropriately. However, the opposite is proving true as markets around the world plummet.

Generally, research indicates that between 50-70 per cent of active funds will underperform their relevant index benchmark in any given year. If you are considering a long-term investment, you should be even more concerned by the performance of active fund managers over the past decade. CNBC reported that 9 out of 10 failed to outperform their relevant index benchmark across most major markets.

This shows that even the 1 in 10 active managers who outperformed, probably did so more as a matter of good fortune, rather than of skill. Active fund managers assure us that in times of distress, high risk and falling markets, they have the tools and smarts to protect investors and their funds.

Predictions are hard, especially about the future

The above was said famously by physicist Niels Bohr. However, we could argue that the COVID-19 pandemic was a highly observable event. There were early warnings, then strong signals, first from China, then from Europe, that this was likely to affect New Zealand’s economy.

By mid-March it was clear major disruption was looming and of course we’re now locked down. So did active managers use the warning signs to their advantage? Did their foresight enable them to protect their customers’ portfolios against the rapid downturn?

Let’s take a look at some results

In the first quarter, markets rapidly followed global and local news and moved from highs into bear territory. What the quarter-end data (which is reported directly from fund managers themselves, including us) shows is:

• 14 out of 15 New Zealand equity funds underperformed Kernel’s NZ 20 index fund. Let’s just focus on that for a second – 93% of New Zealand active equity funds underperformed Kernel’s NZ 20 fund in the March quarter.
• The average active fund dropped 13.6% – 30% more than our NZ 20 index fund, which dropped 10.5%.

For Commercial Property funds, things did not fare much better:

• Our Commercial Property index fund outperformed every large listed real estate active fund, beating our nearest equivalent by 1% and again on average by over 3% (net of fees).

What about the trans-Tasman funds?

• While only 6 out of 10 trans-Tasman active funds (those which invest across New Zealand and Australian shares) underperformed a 50/50 trans-Tasman index, Kernel’s NZ 20 index fund outperformed 21 out of 23 of them.

Whie we acknowledge that in any one year, some active managers can outperform their benchmark, it’s highly unlikely that this can be repeated year on year with assured consistency.

So here’s the bottom line

The numbers don’t lie. Active managers are no more skilled at protecting your investment in a downturn than they are at adding value when the market is rising.

If active managers cannot deliver out-performance over the long term, you have to question what – if any – value they are adding.

This is a repost of an article by Kernel, an index investing platform. It is here as part of a range of views. We welcome an active manager's view.