Passive Investing: The Evidence the Fund Management Industry Would Prefer You Not to See

Passive Investing: The Evidence the Fund Management Industry Would Prefer You Not to See



you investing for the future it's an issue none of us can afford to ignore hardly anyone's job is safe these days how would you cope if you lost yours we're all living longer – so are you saving enough to fund 25 years or more of retirement can you really afford to pay for your children or grandchildren to go to university or help them onto the property ladder and what about all those holidays you promised yourself we entrust the vast bulk of our investments to fund managers here in the UK according to Her Majesty's Treasury the industry has more than four trillion pounds of investors money under management fund managers invest our savings wherever they see fit mainly in equities or shares in listed companies they claim to be experts at making our money grow at picking the stocks that will outperform the market but all too often they disappoint producing returns that are lower than the average return for a benchmark index such as the footsie 100 in London or the S&P 500 in the States if someone said I can beat the market try taking the rate of return achieved by that manager and all other like managers and you will deduct from it the fees charged and there are very few who over a long period of time do better than the market well the best study I know of was one carried out in the States over thirty five years from 1970 to 2005 Matt looked at 355 funds just nine of those funds beat the index by two percent or more over that period and just three of them showed sustained out performance now a study in the UK of 1200 funds and over three years finishing in March of 2011 showed that just 1.3 percent of those fans we're in the top quartile for all three successive years for veteran investment guru John Bogle the problem is simple fund managers just aren't as smart as they'd like to think they are I came into this business when I was at Princeton and I worked for a brokerage firm in the summer and one of the old runners said Bogle I'm going to tell you everything you need to know if you're going into the investment business and I said what's that raven then he said nobody knows nothing and that's true we don't know what the future holds we have all these opinions out there and we've got to say I'm smarter than everybody else and that just isn't going to happen as it means trading against the view of numerous market participants with superior information buying or selling a security is effectively just a bet so whilst your fund manager might lead you to believe it's his knowledge or intelligence that enables you to beat the market he's really no better than a gambler there's a wonderful human spirit that says I can do better that's why we have gambling casinos was a marvelous place for people who own the casino to make a very substantial amount of money over a long period of time by entertaining people and cheerful belief that somehow luck is going to come their way same things true of investing that advertisements about investment opportunity always show that there are great successes right around the corner you could have a – this could be done for you you could be a winner – sad reality is that the quantitative analysis of the hard data would lead to the conclusion that that's just not going to happen very often for very many and for most people most of the time it's going to be just the reverse we can't systematically all pick the winner so the challenge now is okay can I find those great active managers in fact I don't actually argue there are no great active managers I'm willing to say yeah maybe there are some out there my problem is I don't know how to identify who they are it's absolutely possible for active fund managers to be the market and to beat the market consistently over time but there's also the question of probability and when you assign a probability to a fund manager beating the market consistently over time it's very very low so you might be lucky enough to choose the right fund manager but you could just as easily pick the wrong one according to the financial services company best invest there are currently nearly ten billion pounds of UK investors money languishing in what it calls dog funds in other words funds which have underperformed their benchmark index for at least three consecutive years ultimately of course fund management companies are businesses they exist to make money for themselves they want our business even if it means persuading us to invest in funds which the managers themselves wouldn't risk putting their own money in occasionally in the tube stations you'll see one of those big posters would I know stellar Growth Fund make your money reach the skies I'm not a genuinely I laugh you know I look at these and I think yeah right yeah yeah honestly because these funds they're rubbish I mean really you know the vast majority of them are rubbish they will put out any product that they think the public will buy whether the companies have any belief that that product is any good because the idea is to gather assets the idea is to bring in as much money as you can and manage it and if that product fails you you could then take that money and convince the client to go into a different product that you're coming out with back in the 1990s the turnover of mutual funds was only about three percent per year now it's up to almost 6 percent per year so it's almost doubled so to summarise regardless of the impression they like to give fund managers regularly produce less and the average market return buying and selling shares is little more than a gamble and strong returns are often down to luck it's harder than ever before for a manager to outperform the market consistently commercial pressure means fund managers often advertise funds they wouldn't choose for themselves and remember although that our good managers out there picking the next star manager is almost impossible it's now time to look at what it actually costs to invest like all businesses fund managers have overheads running a fund management company isn't cheap especially when the top managers earn around two million pounds a year including bonuses and remember it's you the customer who picks up the tab how expensive is active fund management for the manager in other words what are they spending your money on well part of it is actually the costs of research and the costs of trading the other major major component which is important to any retail fund is marketing to me most of these investment companies are just purely marketing companies let's set up a fund let's see what we can sell and it's never really about what's good for the invest date it's about what's good for the investment company ultimately fund managers need to make a profit in fact they're making around 10 billion pounds from us every year and that's regardless of whether or not they manage to produce a profit for us the job of a stockbroker is to transfer the wealth of the client to themselves typically they extract in the range of 2 or 3% of their assets per year from the clients and if you do that over a period of 20 30 40 years eventually your broker winds up more of your assets than you do we all get a return from the stock market in the long run let's say for the purpose of argument that's an 8% return but we in the markets get the net return after the insanely high costs of financial intermediation and those can be as much as say 2% a year Wall Street if you will in America gets 70% of the return and puts up none of the capital and takes none of the risk and we get 30% of the return we investors as a group there's no way around this for putting up 100% of the capital and 100% of the risk that is just crazy part of the challenge is working out exactly what we are being charged investors typically use something called the annual total expense ratio or ter to compare the cost of investing in different funds but the ter excludes dealing Commission stamp duty and other turnover costs that can add considerably to the expense of investing over time so in addition to those hidden charges what else are we as investors having to pay and more importantly what impact do charges have on the value of our investments in the long term you might be looking at 1.4 annum or more in management fees it doesn't sound very much that if you're talking about investment strategy lasting over 20 years it's a large amount of money that you're actually paying over to the fund manager and you want to make sure that if you are doing that you're getting what you're paying for studies are being carried out and the FSA is very active in this on emphasizing but one of the main determines of longer-run wealth destruction is the charges people tend to underestimate the fact the effect of say a one two or three percent charge each year is very substantial reduction in the wealth and the bad news doesn't stop there despite a marked increase in competition management charges in the UK have been steadily rising over the last ten years charges are an insidious component of the investment proposition and you know for every pound that you pay out in charges as a pound that doesn't go into your pocket which compounds over time and what we've actually seen in recent research shows is that fees in the UK are actually going up rather than going down as they are in the States and as an absolute level they're higher than they are in the States and you know I think there's a lot of talk about charges and fees and fee structures the impact of fees this is an argument they've been having in the States for a long long time but it's only just really beginning to to be held seriously in the UK there are some encouraging signs for consumers the FSA's retail distribution review will require fund managers to be fairer and more transparent when it comes to charges in the meantime investors should be on their guard I don't think the financial services industry cares really about just how much the general population despised and distrusts them they have really not learned the lessons that they should have learned I think it's it's endemic actually to the financial services industry that they lie they dissimulate they they use smoke and mirrors to make us think that something's going to make us money when in fact it's going to make them money we are very cynical and frankly we are right to be cynical so in summary fund managers have large overheads not least salaries and bonuses and you pay the bill overtime charges that sound modest can seriously erode your savings many of the charges that consumers incur a hidden in the small print and to add insult to injury fund management charges have been rising year-on-year so conventional active investing in other words paying someone to pick your investments and decide when to buy and sell is expensive and as we've also heard only very few managers are able to outperform the market consistently but is there an alternative a strategy that costs us less but produces a higher than average return after costs in the long run yes there is it's called passive investing passive investing is really more about the vehicles of choice for a given investor so it's about using index funds as opposed to trying to select active managers that may or may not ultimately best their market benchmark if you take a passive fund that's going to follow the footsie 100 the person running that fund buys shares in every single one of the hundred companies within the footsie 100 so it directly follows or replicates the indexes so the jargon that's used as opposed to an active manager who will say I'll only pick 20 shares is I think the best 20 in the footsie 100 you're then relying on the skill of that fund manager to found the best 20 mathematics tells us then the average active investor in the average passive investor in a market where all of those investors equal the market should earn identical returns net of fees now when we subtract the fees from those products what we see is because passive funds are inherently less costly to operate they tend to outperform active funds over time although it accounts to only a small share of the wealth management industry in the UK passive investing is much more popular in the United States American academics have made a compelling case for it since the 1950s in the 60s economist William Sharpe developed the capital asset pricing model for which he was later awarded a Nobel Prize it has to do with the relationship between the price of a security its risks and its expected return and they're really sort of two key takeaways if you will one is that in that setting the most efficient strategy for an investor is to hold basically a broadly diversified portfolio reflecting the market of securities that are available and that gave birth to the notion of index funds and the second is that there will be a reward and higher expected not guaranteed but expected for barring risk but the kind of risk for which the rewards should be available is the risk of doing badly in bad times after the capital asset pricing model came the efficient market theory developed by Eugene farmer and Ken French the idea being that shares are always priced correctly because they already reflect everything that's publicly known about a company more and more Americans were beginning to realize that paying a manager to buy and sell individual shares was a waste of time and money market efficiency is the idea that market prices adjust very quickly to new information and theoretically one would believe that that market prices would incorporate all the known information that's available and so if that is mostly true which I think it is then it's very unlikely that any investment manager or investment fund or group will be able to have the knowledge and information to consistently take advantage of market errors that doesn't say that other investors are stupid when they go out and hire active what it says is if there is somebody who hires a successful active manager there must be somebody else who's hiring an inferior active manager Western Wellington used to work for a firm of active fund managers but the more he read about the evidence in favour of passive investing the more it made sense almost everybody who adopts this particular investment viewpoint undergoes a similar journey because for most people the only definition of investment advice is trying to forecast the future in some way which stocks will do the best which management's are the best which countries are the best to invest in and so on and it takes a while to understand that there might be a more useful alternative now my particular journey was a function of first 15 years or so doing it the conventional way reading all the usual sources and listening to all the usual experts and never really questioning it but then what I had to undertake a position of making these decisions myself I was the research director in charge of developing model portfolios and I was going to be held accountable for the performance of the various managers I selected I had to keep track of what my performance was when if someone starts to keep track of what your recommendations are it's a bit humbling to discover well maybe you weren't quite as smart as you thought you were it was while working as an investment specialist in New York that Tim Hale came to the same conclusion he believes that many active managers happily gamble with other people's savings while quietly investing their own money in index funds a quick example was when I first arrived I was trying to put forward together an investment performance track record for the confirm that I was working for and ultimately you know being able to find consistent performance within the data that we had and you know I think you know that began begin to sow the seeds of doubt in my mind and my pension plan was full of passive investments which i think is quite a telling sort of indication of I guess the increasing cynicism although public awareness of the advantages of passive investing is very much lower here in the UK than it is in the u.s. British investors actually have more to gain from passive than their American counterparts that's because fund management charges are higher here in Britain than they are in the States no wonder the move away from active fund management is starting to gain momentum on this side of the Atlantic as company pension schemes become less popular investors are forced to do it for themselves so they need to be more and more aware but the low charge is associated with say passive investment well ultimately over a very long period of time benefit them considerably relative to being with active fund managers so to summarize passive investing is not so much a theory as a matter of mathematical fact there's a wealth of evidence supporting it including the work of Nobel prize-winning economists and studies have consistently shown that when costs are factored in passive investing produces better returns than active of course one of the golden rules of investing is not to put all your eggs in one basket and the cheapest and most effective way to diversify is to invest passively why pin your hopes on the shares of just a handful of companies went for less money you can spread your risk by taking a stake in the entire market so this return advantage to passive investing and I also think is a risk advantage in that when you're investing passively you're basically trying to capture market returns so you are not going to be surprised by your investment managers under performance or you're not going to be heavily concentrated in a few number of securities where the risk would be that if those securities do poorly that your results will be very bad is it real in real estate that the three most important things are location location location well my rule and investments three most important things are diversified diversified diversified and then I'll give you three more keep costs low keep costs low keep costs low and the simplest way of doing that is a very broadly diversified very low cost index fund active fund managers like to give the impression their funds do spread the risk you're taking but while index funds often hold hundreds or even thousands of stocks a typical managed fund will only hold around 50 so if you choose an active fund you're opting for greater volatility and you're paying a premium for the privilege if you go overboard on active management you will end up putting your money in too few baskets you'll be under versified so you get very excited by tech stocks or you get very excited by commodity stocks so you put a lot of your portfolio into that and if you do that by concentrating your portfolio on certain areas of the market you pick up a lot more risk than if you have a better balanced portfolio depends how you sort of judge risk but at the end of the day you know you don't want all your investments to be invested in the footsie 100 equally people don't want to have all their wealth in the house that they own and if you use a number of passive investments you lower the cost of that investment to you as an investor and cost is a big drag on investors performance over a 10 to 20 year term active fund managers do offer more genuinely diversified investments recent years have seen a proliferation of so-called balanced cautious and defensive funds as well as funds of funds but the charges on these funds are even higher among the most expensive funds of all are what are called absolute return funds which are supposed to provide the investor with some sort of return whatever happens but in reality often don't not only does the passive approach offer diversification within a fund it also allows you to buy entire asset classes there are index funds for virtually every type of asset whether it's European equities commodities or UK gilts and even when you put your money into riskier assets you're still spreading your risk by buying the whole market to find out how investing passively can help you reap the higher rewards of riskier assets while smoothing out some of the volatility I visited Austin Texas this is home two dimensional a passive investment company specializing in investing in small companies and so-called value stocks when we first started people said look all this tests on market efficiency all these tests were done on large cap managers because there weren't any small cap managers so we feel confident in the small cap area that's the area where they'll be able to add value but if you look at our evidence over the last 30 years that you know there are very few small cap funds of done as well as we have in terms of performance if you ask people where active management works the best the advocates of active management often cite the so-called under-researched or illiquid or unusual asset classes small companies emerging stock markets and that seems plausible to many people well if we look for the last ten years for example least among us registered equity funds putting aside sector funds like those just investing in gold or just investing in one single country like Russia if we look at diversified equity mutual funds the best performing mutual fund is an emerging markets Value Fund all the active money managers are out there they could have bought these same securities several thousand of them that comprise this dimension of risk and return but for whatever reason they chose not to so it was a passive emerging markets fund focusing on this value risk dimension that as it turned out had the highest return among all diversified equity funds for that ten-year period an argument often put forward by proponents of active fund management is that when asset prices fall they often do so across the board true an index fund tracking say the footsie 100 will rise and fall in direct correlation with the index itself but despite the disappointing performance of equities since 1999 a passive investor would still be sitting on a sizeable profit now as long as they'd spread their investments particularly when dividends are taken into account on average that also be better off than if they put their money into actively managed funds and so to that other golden rule of investing always take the long-term view best thing anybody who's going to be an investor could do is to spend a fair amount of time four or five six weekends reading past issues of newspapers start with the 1930s then read the 1940s then read the 1950s and keep on going until you have the feeling gee I really know a lot about markets then the main thing I'm learning is the data that's resent presented and the stories that are written up don't really have much significance over the long long run the remarkable thing about finance is you cannot predict at all what the market is going to do tomorrow but you can predict with reasonable accuracy what the return at least of some asset classes is going to be over very long periods of time you might look at at at the past ten years and say well it's been a Lost Decade US equities have had you know or depending on the ten-year period you measure about a zero return but there are other things that have done quite well you know that doesn't mean that that pattern is going to continue into the future in fact I can guarantee you that that particular pattern won't occur into the future it will be a different pattern of returns but the point is if you will own all of those asset classes you won't screw up you won't make up any big mistakes so let's summarize investing passively is the cheapest and most effective way to spread your risk because their holdings are restricted to a relatively small number of stocks active equity funds and more volatile and passive ones active fund managers charge a premium for funds that invest in more than one asset class and over the longer term once charges are taken into account the passive investor would always fare better than the average active investor let's look now at the impact of investing on our general health and well-being time and again surveys have shown money is the single biggest cause of stress in the Western world we worry about it more than healthful relationships recent economic woes have only served to increase the pressure on everyone to spend and invest what money they have as wisely as possible investing or anything really which involves reward activates pathways in the brain which secrete pleasure chemicals what we call endorphins so when you're feeling a bit of a high or a buzz from having anticipated a reward or thinking about you're going to make some money you're going to get a very good rush of these pleasure chemicals in the brain what happens is that people get almost addicted to that rush and they want to get more and more of it but the downside of it of course is when they lose money or things don't turn out as planned there can be a huge dip in in the feelings and in chemicals that are secreted in the brain I'm thinking of someone I saw quite recently and in fact he hadn't told his wife about you know some of his investments and I mean that they're going to have to sell the house kids education is going to be affected and I think the the marriage is really seriously under threat now because this guy wasn't very sort of upfront about what he'd been doing he thought investing was going to be a solution to many of the problems he was experiencing but in fact it wasn't a solution it's become a huge problem we've already established how passive investing is better for you financially in the long term but it can also spare you unnecessary stress of course financial markets are bound to go up and down but as long as you've taken care to spread your risk across different asset classes there's no need at all for your mood to go up and down with them with the active past there's always the self-doubt I knew I should have done this I I know it should have got out there I've you know they there is a certain transformational experience that goes on with accepting the notion of market efficiency which there's gets to be let's call it an aha moment where people go uh-huh that's what markets work and once that happens they're much more accepting of the fact that markets go up and go down I mean they always have and they always will and there's a at least feel better overall a better overall experience and web experience to me means more than just having better returns it's a better lifestyle as well I think passive investing is a good lifestyle choice because as far as I'm concerned money is something that supports your life it's not something you should be thinking about worrying about fearing about racing after all the time it's something that should be kept in its place you know underneath you and the great thing about passive investing is it works and all you need to do is put your money in ideally wrapped in a nicer if you can or put in a sip or whatever and leave it there the beauty of passive is that because it's a rational approach rooted in mathematics it takes the emotion out of investing in motion you see can seriously damage your wealth it is human emotion it is behavior that drive stock markets up and down take away that sort of irrational behavior as it were and you get a more sort of sensible level of investing which is why the way most people invest they invest over time five ten twenty years so we have to remember that the media doesn't like neutral stories they only like the rather extreme stories so it's easy to get swayed by the media and of course men are avid readers of financial pages and we know that women aren't and there may be something in that because men also more likely to react to what they read to talk about it again with perhaps peers and colleagues and to feel that we have to act upon it and I think the secret of the good investor is probably to be able to tune out a lot of what goes on in the media because it probably isn't particularly useful we tend to want to be in tune with the people around us because human beings are such social such social creatures and again the reason for that is is evolutionary and so where everyone else is buying we tend to want to buy when everyone else is selling we want to tend to sell and that means two things it means that markets are can be very unstable if everybody is buying at the same time and then it turns around on a dime and everybody starts selling at the same time you get a great deal of volatility and then you also wind up doing the wrong thing at the wrong time by constantly buying and selling the funds or buying and selling individual stock that Wretch's of the cost even more our philosophy is you rebalance according to the way the portfolio should be sitting so what I mean by that if you're supposed to hold 40% in equities and 60% bonds and it goes to 50 50 or 30 70 that triggers our rebalance and the beautiful thing about rebalancing based on percentages it takes away the emotion I think a passive approach to investing you is a way of protecting yourself against some of this unnecessary stress that people get from over turning over monitoring their investments so really a good plan that's only visited perhaps by an annual review will be enough and you can spend the rest of your time enjoying your life and doing things that are less stressful so to sum up money worries in general and poor investment decisions in particular a major causes of stress rational analysis produces sensible investment decisions emotions lead to bad ones and the better returns stop fretting about your investments and enjoy life an annual review is all you need you might be thinking this all sounds just too good to be true passive costs you less money and yet it offers you ultimate diversification it's good for your health and ultimately your wealth but if passive really is superior to active in so many ways why aren't more people doing it let's find out perhaps the single biggest reason why active still hold sway is the fund management industry itself it's a powerful sector with a vested interest in maintaining the status quo when you have a market that's a trillion dollars and they're able to scrape off twenty billion dollars a year or two percent per year from that to feed themselves they don't want to give that up so there's a lawful lot of a marketing and a lot of a convincing of the public that they need active managers that mean they need to pay 2% per year it's all about keeping the money in the pockets of the people who are creating the funds as opposed to putting the money in the pockets of the people who are taking the risk of course the industry spends vast amounts on advertising the news media might also play a part in making us invest the way we do there is quite a bit of evidence that when when you're dealing with very complex issues such as investing that the complexity is so severe that people end up just going with quick hunches and you have a whole industry out there the finance industry that is built on the eye on the minutes built on an illusion that that there's a free lunch out there that's what you're being sold every day in the magazines because you know a magazine can't make money saying you know you should be passed even to the same this year as you did last year we could have an article week after week after week telling people you know passive investing that's the way to go that story gets old there's no news here versus I'm trying to write an investment story this week I have this really beautiful articulate woman who's got a strategy next week I've got this really handsome outgoing gregarious guy who has a strategy they all make the cover of my magazine makes it much more interesting versus me put me on the cover you're not selling anything there's another explanation I think which is over evidence there is a mountain of literature from the psychological field explaining that people for whatever reason exhibit this persistent behavioral characteristic we tend to both think we know more than we do we think it's easier to see the future than it actually is and it's fairly straightforward to document this what's more interesting is that the research also tends to show that even when you point out these behavioral biases to people they continue to engage in it I think passive investing is less popular than using active managers because in many ways it seems inherently defeatist it's almost saying I don't possess the skills to select a superior manager that it's impossible to beat the benchmark so why even try I think this almost the defeatist angle really turns some people off to the idea of passive investing because after all we all ultimately believe that we're exceptional even with the knowledge you know that passive investing is better than a lot of people still won't adopt it because they like to think they can do better you know it's human nature everybody thinks they're a better than average driver you know and in the same way they think that they can pick a better fund better than anybody else for others the main reason why active investing is still far more popular than passive is a simple lack of awareness among the general population primarily I would say it's a lack of education but then secondly passive funds because they don't make much money for the financial companies while they do make money for us they're really not promoted people are simply confused most people don't get the opportunity to hear that you know active investing is clearly a negative sum game just in adding up constraint no science just arithmetic that's news to most people it's not about getting investment returns or superior returns above the rest of the market or beating our competitors our job is to educate the general public and I do believe over the next 10 – 15 years the general public will realize that the only way to have a successful investment to experience is to own as much as the market as you can be well diversified and make sure that you sit in a really really diverse portfolio with substantially reduced charges in summary then the largely self-regulated fund management industry has a vested interest in maintaining the status quo human beings have a tendency towards overconfidence and that's reflected in the way we invest and while active funds are widely advertised passive funds aren't and nor do they command much media attention so what does the future hold for the passive approach when fund management companies are spending vast amounts of our money trying to convince us that active is best can passive really challenge that perception people have but if only they find the right manager they will beat the market well actually classifiers been growing in popularity in the United States for many years and all the signs are that it's starting to take off here in Britain as well when a company called Vanguard introduced the first index fund for individual investors in 1976 critics said it wouldn't catch on it's now one of America's largest investment companies with more than one and a half trillion dollars of assets under management and it's expanding worldwide when we first opened our London office in 2009 we had three employees there and I think in the first couple of months there were a hundred different articles written about us coming to the UK and they said that was the best press coverage per employee of anywhere in the world and what would it really underscored for us was I think the British financial press saw you know we call it the Vanguard effect you know bringing somebody like us into the market would put a much more focus on cost diversification quality of service and so forth in fact Vanguard believes that passive investing has far greater potential in the UK because the cost of active fund management is higher over here than it is in the US investors in the UK are paying very high costs to gain exposure to the market we're very excited about our opportunities to expand here because we think by offering a very low-cost way of gaining exposure to the marketplace will provide a great service to investors I think passive investing is going to it's going to go through one of these exponential growth periods that's really our bet in the UK I think it would not be surprising to me that if that's 7% of retail assets that are currently passively managed double in the next decade that would not shock me at all although passive still accounts for a very small share of the retail investment market in other words the market for individual investors institutional investors already have 30 percent of their portfolios invested in passive funds the trend is definitely towards more money being invested in passive as investors become aware of the fact that performance over long periods of time is very good for passive funds and the costs are very low and a very important ingredient of a good performance is the little cost and the researcher suggested that low cost is in a good predictor of future performance one of the companies helping individual investors to take advantage of the lower costs and higher than average returns offered by passive investing is Barnett Ravenscroft wealth management we got together and we decided that we needed to assess everything properly and we took time out over a period of about two years we're just looking through academic all the academic research that was available and it became evidence you know after looking at was that what was out there that the passive approach was best not only for Barlet Ravenscroft as a firm but for all our clients I think for once we've actually got to say what are we in this business for is to service the client and make sure that they're the ones that are successful it's not about that clients got X amount of pounds let's take that money oh and look at the benefit to us look what we can charge them if we can focus on giving the best investment experience will keep the client for life they'll work with us for life they benefit and indirectly we benefit there are also signs that the media is becoming more receptive to the arguments for passive investing several independent internet sites which unlike the financial press don't rely on fund management companies for advertising revenue and can therefore say what they really think about active funds are also starting to recommend it you've got more and more websites like like mine money magpie and also of course the Motley Fool which is promoted passive investing for years and more and more I would say people who know are saying actually you know you're better off with passive funds so that trickles down it's like fashion you know when when the top people are saying the same thing and gradually they're moving in that direction that does trickle down our forecast going forward we'll see more and more of money invested in the UK moving toward passive the advantages are just too strong as people become better informed you see more and more people saying I'm going to give it up I have not succeeded in the past trying to invest actively I'm going to give up trying to do that I'm just going to go passive where I can be sure that on AB that I will be the average active investor there will always be a large number of people who are overconfident enough a large number of participants who are overconfident enough that they'll try to beat the market but at the same time that the pattern that you say and the trend that you see is a increasing passive management particularly in this this country assets are flowing away from active managers away from stockbrokers and they're flowing toward companies like Vanguard you're flowing towards advisors who manage money passively where does it equilibrate out I suspect 50/50 won't be far from it so to summarize passive investing has grown steadily in popularity in the United States since the 1970s and continues to do so passive already accounts for more than 30% of the institutional investment market in the UK and increasingly both financial advisors and independent experts are starting to recommend it to individual investors in 1973 an American economist named Burton Malkiel wrote a book that's become a classic it's called a random walk down Wall Street now though he backed it all up with detailed statistics charts and studies his argument is a simple one you can't predict share prices if you do manage to beat the market it'll be more than likely down to luck even then transaction costs will likely cancel out any extra returns you make as for picking the next star fund manager you might as well forget it to quote the author himself a blindfolded chimpanzee throwing darts of the stock pages could select stocks as well as the experts in the intervening 30 years the fund management industry has poured scorn on malkiel's theory but no one so far has managed to disprove it now in his 70s very wealthy Malkiel is more convinced than ever that passive investing is the rational choice for every investor you every time I do a new addition the 10th just came out I ask myself is the hypothesis true do index funds outperform and every time I do it I find that index funds do better than about two thirds of the actively managed funds and then when I look at it in the next period I find exactly the same thing and the one third that beat the index in one period aren't the same one-third that beat the index in the second period in fact despite there being a wealth of evidence in favor of passive investing produced by some of the world's most distinguished economists and statisticians the intellectual case for active investing has been almost non-existent actives most vehement supporters a fund managers themselves ie those who earn a very comfortable living from it I find as a generalization most active money managers have little interest in these debates if they are involved in a debate at all they simply point to people who have been successful at managing money and say this is proof that active management works well it isn't proof because it's not doesn't demonstrate that the results are any better than luck but it's it's the best they can come up with one former active manager who converted to passive says many active managers privately admit that passive makes much more sense when I convert it over to passive and I started writing about index funds and how my Peters are going to have a very difficult time beating the market and here are the statistics and here are the data I can't say that I was invited to any more parties I was we can't say that I was shunned because I could show up to the parties just because I was part of the group but I wasn't invited anymore now I will also say though that one on one with my peers in a private setting where nobody could hear the conversation they would readily admit that it was very difficult for them to beat the market and that they personally believed in what I was doing and this is what Warren Buffett the world's most successful active manager says about passive investing most investors both institutional and individual will find that the best way to own common stocks is through an index fund that charges minimal fees I particularly like the fact with passive investing but you put your money in and if you're sensible you don't even think about it more than once a year that's what I've done and that's what I recommend to people who don't have the time or the interest to spend a lot of time in front of screens learning about companies learning about sectors reading company reports etc I don't have that time you know and I'm working in money I don't have that interest if you do have the interest really to spend the amount of time that you need to you know the kind of time that Warren Buffett for example spends then sure but on the whole for most people who have lives who have jobs who have families passive investing makes perfect sense and having mentioned Warren Buffett he thinks the same so hey you know can't be that bad eh of course the passive approach doesn't guarantee big returns no matter how long your timescale but even in turbulent economic times such as these a balanced passively managed portfolio carefully weighted to match your own emotional tolerance of risk does guarantee something even more valuable than that peace of mind people often ask me with regards to our clients do they contact me with worry about what's going on the answer to that is no they don't because when I say they join a program our job is to educate once they've been on the program for 12 to 18 months they are probably better armed to actually know more about investment management than probably 60 to 70 percent of the financial advisors and some of the fund managers now you may have noticed that we've deliberately avoided singling out specific fund management companies for criticism as long as you read the small print you can see for yourself how much each company charges and it's easy enough to find out whether they really do deliver the returns they say they can but we did ask the industry regulator the Financial Services Authority for an interview this was its response unfortunately we will have to decline your request to participate in the program the FSA has strict rules about being seen to endorse a particular firm and that will prevent us from participating indeed this film has been funded by a company that specializes in passive investing but given all the advertising for actively managed funds that we're constantly bombarded with also privately funded of course using customers money you could say it's about time that someone redressed the balance so you've heard the main reasons why we think the fund management industry is letting investors down and why a passive investment portfolio is the right solution for the vast majority of investors but don't just take our word for it why not investigate a little further it won't take long nor will it cost much if anything at all but financially at least it might just be the best investment you'll ever make I think with a lot of investors who go into the passive investing side and go into the indexing pod it's a road of self-discovery so something sparks their sparks them to start looking into it and once you start looking into it and you read a book and it leads to another website it leads to another video and all of a sudden you have like what I had which is a chemical reaction and you say I get it you

45 thoughts on “Passive Investing: The Evidence the Fund Management Industry Would Prefer You Not to See

  1. There’s something about the British and the Americans in regards the economy. These two came out of the Great Recession faster than any other countries.

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  4. I think the greatest enemy of successful investing is impatience. Passive investing will lead to highly successful results over a 30 year period, but most people want a more immediate reward. Unfortunately, very few market investments will produce results quickly without considerable risk.

  5. Buffett says if you are a full time active investor you should only hold 5-6 stocks…as you can't know 10-20 companies as well as 5-6…..But if you have no interest in stock analysis ALWAYS invest in Low cost Index Funds..he recommends Vanguards.

  6. Why does everyone in this documentary have a black- or white perspective. Sometimes the answer lays in the grey.. Some periods (for instance during financial recessions) active investing can be shown to be better. So why not talk about a combination of these to rather than a either/or stance?

  7. Confession: was a stock punter. Had overconfidence in trading FA and TA. Came to light when studying more. Join us at bogleheads forum =)

  8. Nobody can beat the index now. Not even Ted and Tod of berkshire hathaway with their 13 Billion dollar fund. Charlie munger even predicted the collapse of new york based fund industry.

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  10. It feels like this film is also trying to sell the idea of index funds. But show me who's become rich by investing in index funds and getting their annual 10% avg and loosing the whole profit after the decade during recession. Definitely not Mr. Buffett or Mr Bogle. If you have a very strong buying power go ahead otherwise you'll get asleep waiting for your wealth. It's simple math.

  11. Investing in low cost index funds is better in developed economies, but in countries like India, actively managed mutual funds perform better than low cost index funds

  12. People need to stop whining about how much Wall Street makes off of people, and instead educate the public to move to passive investing with index funds, low costs, low turnover, etc.

    All the information you need is in a prospectus and online. But most people don’t want to take the time to read the “fine print” so they throw their money haphazardly to people they’ve never met, or will never meet.

    Wake up people.
    As the old adage says, buyer beware.

  13. warren buffett is sitting on 120 billion if he believes in passive investing why has nt he put it there?

  14. This is just superb, I've been looking for "warren buffett tips for investing" for a while now, and I think this has helped. Have you heard people talk about – Rondalyn Coinage Carnalite – (do a search on google ) ? Ive heard some amazing things about it and my cousin got cool results with it.

  15. Do your own research. Buy between 20 and 30 stocks that have had good steady growth and just hang onto them. Review your portfolio once or twice a year and make adjustments as you deem necessary.

  16. Taking a risk in the entire market is no different than gambling your money in a casino. There is no guarantee that investing in the market is any safer than gambling. Because the capitalist system is flawed.

  17. We are immigrants entering USA 1963. Penniless. With meager earnings we lived in Chicago slums for years. Saved and invested in mutual funds ever since. No advanced education. 401 k, IRA, annuities and mutual funds until today. Single income. Wife was / is housewife raising our son and keeping us healthy with home cooking. Modest lifestyle. We are comfortably retired as were as my relatives in Germany are struggling. Germans in Germany do not like stocks. God bless America!
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    REPLY

  18. Index funds track the index, but what do you suppose an index is? It is just another actively managed list of companies. The SP500 has seen on average 23 component changes annually over the past 50 years, and looks completely different compared to the list at inception. Active institutional investors, through the flow of capital, determine which companies are removed or added to an index, so really index funds are just tracking the flow of active institutional capital (with the benefit of avoiding the losers, since they are not added to the index). Without venture capital and other institutional investors, the capital markets simply won't work.

    If the market was 100% passive investors, Facebook, Google, Amazon, Apple, Microsoft etc would never get the capital needed to start up, as all the passive investors would be waiting for them to get added to an index first, which would never happen.

  19. I think the underlying facts are this. There are good active funds and bad ones. Yes index are better than bad ones. But indexs do not out perform the good ones. Indexs are perfect for the risk averse but they will not leave you with much in retirement/future

  20. Why do people actively invest even if they know the statistics?

    Just look at casinos. People there know that the odds are against them, but the greed and desire to be the tiny percentage that may win big takes over. Why make a lot of small gains over time that equal big gains when with the right luck, you can do it all at once, even though the odds are dramatically against you being that person.

  21. How is it even possible that the market goes up every year? Shouldn't it look more up and down ish? Weird

  22. This is true if you want to average over a 10yr short-term debt cycle. However, if you are unfortunate to invest into an index fund (like S&P500) right before a recession, then you will have very small returns and risk to lose a huge chunk of your money. So, stock picking is good before and during recession and an index is good in all other times.

  23. As I'm watching each of these passive investing videos from buffet and b ogle I find my slowly selling more of my active funds and buying more of the passive.

  24. For the Passive investing to function properly, as it's doing these days, Markets needs to be efficient. By that it means that the individual stock prices must reflect all the available information regarding this individual stock, plus a market risk premium.
    this is simply impossible without the active investing. which allows active investors to exploit anomalies and/or mis-pricing in individual stock prices or even the market as a whole.
    So, you really can't have one without the other.

  25. In the 1970s and 80s, Fidelity's Magellan Fund did better than the S&P500, and grew to 10-20B. Its lead manager, Peter Lynch, was often interviewed in the business press. But one day around 1990, Peter Lynch took very early retirement, and the Magellan Fund ceased being the darling of the business press. 1-2 years after he quit, in an interview in Forbes or Fortune etc., Lynch said that most equity investors would be better off investing in an index fund. It was widely speculated at the time that Lynch cracked under the pressure of having to deliver year after year, returns in excess of the S&P 500. Last century, it was common for a successful mutual fund to "close its doors" to new investors. Management admitted that if unlimited inflows were permitted, they would have to invest those inflows in stocks that management did not expect to outperform the market on average. Hence the doors had to be closed in order to preserve the high returns of older investors. Even today, some of Vanguard's traditional funds are closed to new investors.

    One of the many advantages of index funds is that they can grow at will and never have to close their doors. This is important, because I have calculated that Vanguard's index funds are worth about 2.5 trillion as of the end of May 2017. Vanguard's fund indexed to the Wilshire 500 (S&P500) is worth about 500B (300B). An index fund can be managed by computer algorithm. An algorithm that works for a 10B fund also works if that fund grows to 1 trillion. The care and feeding of such an algorithm does not vary with the amount of assets under management; hence Vanguard's economies of scale. If you invest 3-5B in Vanguard's fund indexed to the US stock market, its management fee is 1 BASIS POINT. Meanwhile, I read all the time about the managers of DB pension plans and of university endowments charging an unconscionable 80-150 basis points.

  26. What percentage of businesses grow faster than the S&P? The problem is all the scams damage the reputation of the industry.

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