Tuesday, 3 February 2009

In search of honest beta...

In recent months we have seen how miserable markets can perform. Most of us know we do not know enough to manage our own investments, hence we appoint professional money managers to do just that; i.e. to protect and grow your investment. Yet, the reality is startling, we do pay them professional fees alright, but the chances are very good that the expected professional performance may be missing...

Lex wrote the following in his daily column on FT.com:

Faith in the genius of stock-pickers is at an undeniably low ebb. Institutions are now paying heed to the evidence of a series of Standard & Poor’s studies which suggest that the best way for investors to guarantee their fair share of market returns is to throw the net as wide as possible while keeping fees to a minimum.

Over the five years ending in June 2008, almost 70 per cent of actively managed large-cap funds failed to beat the S&P 500. Measured against mid-cap and small-cap benchmarks, active funds did even worse.

By buying an index fund investors won’t get the best performer, nor the worst. But they don’t have to worry about whether the star fund manager will chuck it in to grow grapes in the Napa Valley, or whether the team as a whole will be subject to some unforeseen, value-destroying behavioural bias. For that peace of mind they’ll pay about a third of the fees charged by the typical active manager.
The influx into passive funds will not last. When bear markets fade, investors tend to start believing in their own ability to find individuals who’ll consistently beat the benchmark. But for the time being at least, they’ll take cheap, honest beta over illusory alpha.

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