GOLFERS are familiar with the concept of a “mulligan”—the chance to retake a shot. Give an averagely talented player enough mulligans and he or she will get one close to the hole. And a version of the mulligan exists in fund management too.
Readers will be familiar from past blog posts with the idea that actively managed funds cannot be relied upon to beat the index. Many of these studies are conducted in the US market, which is probably the most efficient (and thus hardest to beat) in the world. But the same is true in Europe.
Upgrade your inbox and get our Daily Dispatch and Editor’s Picks.
Will the justices strike down California’s abortion notification law?Democracy in America6 hours ago
China is seeking to become a “cyber superpower”Graphic detail8 hours ago
Mike Pompeo’s evangelical zeal could complicate his new diplomatic lifeErasmus9 hours ago
Beware of performance figuresButtonwood’s notebook9 hours ago
The mysterious reggaeton bangers of Mexico’s electionProspero10 hours ago
Economic and financial indicators13 hours ago
Figures from S&P Dow Jones Indices show that, over the ten years to December 2017, less than 15% of euro-denominated European equity funds beat their benchmark; for emerging market funds, it was less than 3%; and global funds, under 2%. For sterling-denominated funds, less than a quarter of both European and UK equity funds beat the index.
But I took a closer look at the UK market, because of an intriguing detail. The annualised return of UK equity funds was 7.27%; the index return (S&P’s broad market index) was 6.48%. So how come the average fund beat the market when, the figures also show, most funds did not beat the market?
This is where the mulligan rule comes in. The ten-year performance returns are for funds that have survived ten years. But most funds did not manage that; only 43% of UK equity funds that were being operated at the start of 2008 were still going at the end of 2017. The ones that closed were, inevitably, ones that underperformed. If a fund survives for ten years, the chances are that it had a pretty good record. That is why managers can advertise funds with strong performance; if they have a bad fund, they can just close it and start again.
Ah, some investment advisers might say (indeed, one did tweet this to me) all passive managers will underperform. But I looked at the Legal and General UK index tracker, which is one of the largest, if not the cheapest. Its compound ten-year return was 6.4% (it tracks the All-Share not S&P’s index). It will never be the best performer in the sector but clients can be sure it won’t be the worst either.
So beware of performance numbers. Another problem occurs with those funds that do become stars (think Bill Miller at Legg Mason). They start small and then their good performance generates investor inflows. Sometimes, it is harder to outperform with a big fund than with a small one. But traditional performance figures look at the return of the fund, not that of the average investor. Say that the fund had $20m in the first year, and returned 20%, generating inflows of $100m at the start of the second year. In the second year, the fund has $124m under management and earns 5%. The fund will have a two year average return of 11.8%. But most investors will have only earned 5% since they only joined for the second year
Use a dollar-weighted return and the average investor can lag 2.5 percentage points behind the average fund; that is what happened in the ten years to end-2013, according to Morningstar. There is a reason why its is easier to get rich investing other people’s money than to get rich investing your own.