Trackers or active funds: what the evidence says
An index tracker buys the whole market and charges very little. An active fund pays a manager to try to beat it. After costs, most active funds don’t, and it’s hard to tell in advance which ones will.
The arithmetic
Before costs, investors as a whole earn the market’s return, because together they own the market. Active managers are a big part of that whole, so on average they earn the market’s return too, before costs. Take off their higher charges and trading costs, and the average active pound must trail the average tracker pound. The economist William Sharpe set this out in 1991 in “The Arithmetic of Active Management”. It doesn’t say no one can win; it says the average can’t, after costs.
What the results show
S&P Dow Jones Indices compares active funds with their benchmarks in its SPIVA reports. Over ten years, most active UK equity funds have fallen short: 62% in the report published in 2021, and 73% in 2015. The share varies from year to year and is usually worse over longer periods, partly because many weaker funds close or merge and disappear from the records.
So why does moatshark follow active managers?
- To learn, not to pay. The handful of managers here are worth studying because of how they think: buying businesses below their value and holding them for years. Their filings are free.
- Long records are rare. A few have beaten the market over decades, but past results don’t guarantee future ones, and picking the next one in advance is hard.
- Many of them say the same. Warren Buffett has long said that most people would do best in a low-cost index fund.
A sensible middle way
Many investors keep a low-cost tracker as the core of their portfolio, and, if they enjoy it, a smaller part in a few businesses they understand well, held as an owner would. My portfolio shows those holdings the way an owner sees them.
Where to go next
- Work out what your charges cost you.
- Read the source: S&P SPIVA research and William F. Sharpe, “The Arithmetic of Active Management”, Financial Analysts Journal, 1991.