Today active asset managers are under pressure to a degree rarely seen before, writes Anthony Hilton. They have been judged to be poor at delivering significant value in a low-return world and large numbers of customers have decided they would be better off buying an index-tracking fund where charges are far lower.
Indeed according to Morningstar, a research house, US investors withdrew $246bn from active managers last year and you have to go back to 2005 to find a year when there was a positive net flow of money.
Investors may be more tolerant, however, if they better understood how the greater pace of technological change is significantly shortening corporate longevity. Only two of the world’s top 10 companies of a decade ago are firmly on the list today and most of the current winners barely existed a decade ago.
People complain about the rate that fund managers turn over their portfolios these days but, in their defence, the death rate of companies makes a buy-and-hold strategy a far from certain route to success.
AGAINST THE ODDS
This has deep implications for the whole concept of active investment management. Just how deep was raised in a recently-published work by Hendrik Bessembinder, a professor of finance at Arizona State University.
Bessembinder looked at the performance of every single quoted US share month-by-month from 1926 to 2015 – some 26,000 stocks in all – and found that fewer than half made any money for the investor. Indeed, in his model the most common single result from buying a share was a total loss.
This tied in with the fact that the median lifespan of a share in the database was just seven years. Because of this casualty rate his stark finding was that in 96% of cases investors would have been better off buying one-month US government T-bills, which carry virtually no risk and have a minimal return.
Turn this round and the challenge to the active manger becomes even more obvious. Bessembinder’s research shows that only 1000 stocks – less than 4% of the total – accounted for the entirety of the $31.8trn of wealth created by the US stock market in the last 90 years. Within that total only 83 stocks accounted for more than half of the gains.
Exxon provided 3% of the total and Apple 2%, but Bessembinder’s telling observation is that you have as much chance of getting in on the ground floor with stocks such as these as you have of buying a winning lottery ticket.
At first glance, this is bad news for active fund management. If you accept that finding a winning share is like trying to find a needle in a haystack then it makes sense not to bother.
It would be better to buy the whole haystack instead – because the needle is in there somewhere – and that is exactly what investors are doing when they buy passive funds. But in fact it makes the opposite case.
Companies are born and they die, but between those extremes they can have periods of great excitement. Just because a business is worthless at the end does not mean it was worthless throughout its life.
Most likely there were periods when it was a worthwhile investment. Bessembinder has demonstrated that if you hold a stock too long the chances are you will lose money – but if you are nimble there is ample opportunity to make money and bank profits before the end comes.