Active investing is the most popular ‘unpopular strategy’ in the world.
Critics continue to hound this approach for its lacklustre results. They point to the persistent underperformance of active mutual funds as excellent evidence that active investing doesn’t work.
It doesn’t matter how much an investing course tells you that passive investing could give you a 1% edge over active investing. Sometimes numbers don’t win the argument, even on financial matters.
The main figure which makes this apparent, is the average return of an actively managed fund, after fees, compared to the stock market benchmarks they are compared against.
Against these benchmarks, the majority of active funds fail to beat their benchmark. That’s right – on average, a mutual fund will not even equal the benchmark in any given year.
Given that a passive index tracker would hit reasonably close to the benchmark every time, this data puts active investing in a very vulnerable position.
After all, fund managers have access to the brightest staff, the fastest internet connections and years of professional investment experience. If all of this cannot produce premium returns to even cover their own fees… what’s the point?
Active management still thrives
And yet, assets under management at active mutual funds remain a huge figure. Sure, $1 trillion of investor money has left active funds in the last decade, but this is only a small portion of their assets under management. There’s still plenty left being run by this old-school approach to fund management.
Why active management still has an active following: trust
Active management inspires trust.
Active fund managers have glossy brochures and marketing teams to sell their products to the public.
They may advertise as ‘independent and owner managed’ – given the impression of hands-on attention from a dedicated founder.
They may describe their fund managers as having interesting or exceptional judgement, such as one fund manager which states ‘Our managers have the freedom to invest without the constraints of a single house style or process’.
Others may point to an excellent track record of returns (for a specific fund which did happen to beat its benchmark). Albeit with plenty of legally required caveats that past results are not a good guide to future returns.
All of this helps to build a relationship, a brand and ultimately some trust in the abilities of the fund manager.
Investing can be a scary process for investors. The stock market can be wild and volatile. What cautious investors want is reassurance and to know that they have hired an expert to manage their money for them.
This is where active funds excel, because they are able to address all of these concerns. Regardless of whether they beat their benchmarks or not!
Human versus machine
It’s similar to the question of whether trams/subway trains should be driverless or not. Even if the data showed us that an auto-pilot system would reduce crashes, many people would still feel safer with a human driver.
Index funds are the autopilots of the investing world. Their cold, calculated approach might indeed produce some advantageous returns. But it cannot inspire the same level of trust, particularly for older investors who want the reassurance that an intelligent human mind is making decisions on their behalf.