In one of the most critical articles we’ve published since starting WellSpent, we explained what the theory of efficient markets is and how index investing earns you the same returns as managed funds over the long run, and for a LOT cheaper.
In that article, we stressed that buying a unit trust purely on the basis that it did well last year is naive and not a great move. The Asset management industry hands out awards like winemakers, so don’t put too much emphasis on how important they think they are.
This conclusion all revolved around the active vs passive debate; do fund managers who actively manage your money in a portfolio add any value over the long term, over that of a passively managed fund that simply tracks an index? Should it be that an active manager is not adding any value vs. a passive fund, then the fees that you’re paying them are a drag on the long-term performance of your investment portfolio; deadweight if you will.
Prior success does not predict future success
If you trust in the strategy of passive investing then you must realise that choosing to place your money with an asset management company simply because they did well last year, or in any year for that matter, is illogical. The fact that they did well last year was, simply put, not their doing.
Asset allocation is the real driver of investment performance, NOT the people who manage the funds.
We’d hazard a guess that almost every asset manager has similar wording at the bottom of their webpage, brochure, and fund documents. A quick sample from a well-known asset manager’s literature reads as follows:
Important information that should be considered before investing in the XXX Fund
The XXX Fund should be considered a long-term investment. The value of units may go up or down, and is therefore not guaranteed. Past performance is not necessarily an indication of future performance.
Note where we underlined.
We like to think that they include this for two reasons.
The first is that they want to disclaim away any notion that you might have that because their fund did well last year, you are entitled to expect it to do well this year. The last thing they need is thousands of investors wanting their money back, after having being sold some kind of implied guaranteed return.
The second, is that they know that their ability to outperform an index that matches their benchmark over the long-term is not within their control.
The irony about all of this, is that if you’re the Chief Executive of a big asset management company, the only way you have to differentiate yourself from all the other asset managers, is to advertise your funds that previously did well, hoping that the public will believe that you’re good at what you do – making people more money.
To trust in passively managed funds though, is to see through this advertising as a waste of time. It’s a waste of time to you if you were doing your due diligence as to where to invest your money, but it certainly isn’t money poorly spent if you’re trying to convince the uninformed investor that you’re worth the fees you charge.
What really matters if results are the same?
Imagine though if everybody’s passive index fund performed exactly the same as everybody else’s. How would you then choose between different asset managers?
The best client reporting?
The friendliest call centre?
Or maybe the one with the best screenplay for their tv ad?
As silly as this all sounds, this is where your headspace needs to be right now.
Being the marketing exec at an Ad agency for a big asset manager must be one heck of a tough job. You would need to come up with reasons to get the likes of you and me to invest with a particular asset manager, for reasons other than actually giving you what you think you’re paying for – higher returns.
But maybe that’s just advertising in general?
Who can you trust?
So where should you be looking for a place to manage your money? If the guys who are telling you how wonderfully they did last year are selling you snake oil, what’s a person to do?
We think it far more important to find an extraordinary financial advisor. Remember that it is a financial advisor who will help you make decisions around how much you should be investing in the various asset classes, after having done a comprehensive and considered approach of your personal financial needs.
It is far more important to be exposed to the correct and appropriate asset classes than it is to find the best asset manager.
Asset managers are simply the ingredients in a wider concoction that is your financial life, and in many instances the ones that charge you the least fees, are the best ones.
This is all part of a wider topic on financial advisors that we won’t get into detail now, but people’s unwillingness to engage in getting financial advice is no secret. Whether it’s because of the history of the industry or people’s inflated belief in their own ability, trillions of dollars, rands, pounds, yen….pick one… have been transferred from long-term savings of investors to shareholders of asset management companies.
If you really want an edge over life, and figure that you need all the help that you can get, given that you’re 35, and pretty much live payday to payday, then find a brilliant financial advisor. Ask your most financially adult friend for a recommendation or stay tuned to WellSpent for something we’re working on behind the scenes.
A trusted and honest advisor who truly understands core principles like index investing, diversification, and the risk / return tradeoff, means you’re in good hands.