I was interested in recent research from University College Dublin, which showed that trying too hard at golf is probably counterproductive. I recently wrote a newsletter about some common mistakes investors make, and why investing is like golf, so it's nice to see one's opinions validated by experts. In the 12 years to December 2003, chasing alpha cost the average UK investor about 4% per annum—the cost of getting it wrong is just too high.
Strange, isn't it, that in the incestuous investment world we inhabit, any one of us can only think of half-a-dozen or so outstanding fund managers off the top of one's head—and I'd like to bet that myself and my readers would come up with the same half dozen. The fact is, folks, there aren't that many good fund managers out there; and of those that do appear to be good, it takes 16 years to determine, statistically, whether that outperformance is due to skill or luck. And by that time, he or she will have moved on, more than likely.
Which is why, until someone demonstrates a fail-safe ex-ante process to select the next Neil Woodford, or Anthony Bolton, or whomever, I would much prefer to use nice, reliable beta—as much as the client needs or can stomach—to generate client returns. And for this to work properly, one needs to get as close as possible to the return of the asset class, the risk of which one is exposed to. It is only fair that one enjoys all the buck in return for the bang to which one is exposed.
One obvious way of helping with this is to be totally ruthless about costs. Another is to ensure that tracking error, how close (or otherwise) one hews to the return of the desired asset class, is kept very low. The advent of the Exchange Traded Fund (ETF) has made this very possible, even for the most esoteric of asset classes.
Also, Vanguard, one of the world's largest providers of index funds, is about to launch some funds in the UK. Founded by investment guru John Bogle in the 1970s, Vanguard has become synonymous in the US fund management business for two things—the lowest tracking error in the business, and extremely low costs.
Let's hope that Vanguard, either directly, or indirectly by encouraging competitors to reduce their costs, force down the charges for fund management on this side of the pond. If, because of tiny costs and very low tracking error, financial planners can deliver reliable beta to our clients, than that is what we should do.
Research has shown that clients would rather we didn't spend our time (and their money) on chasing elusive and diminishing extra returns, but on much more valuable things like long-term financial planning and investment counselling—in making sure that the clients actually enjoy the returns they set out to achieve. Around 2% of the 4% under-performance mentioned above comes from chasing the dragon of superior fund performance across the investment cosmos. If a planner can save a client from such destructive behaviour—can, almost literally, rescue him from ripping up and burning, every year, £2 of every £100 he has invested—that has got to be worth far more than selecting a fund manager, with the remote possibility of striking lucky and hitting on one of the very few who got it right.
Having a widely diversified portfolio of asset classes, populated by ETFs and passive funds with low costs and tracking error, is the investment equivalent of playing all the world's championship golf courses and being guaranteed to hit par. You may say, hey, I quite like going out there and trying my very best every time. Fine, but tomorrow is another round of golf; most of us only get one shot at funding a decent retirement, and all of only get one shot at life.
David Crozier CFP