With the strong growth in index funds and exchange traded funds (ETFs) in the Australian marketplace in recent years, debate is again swirling on the benefits of active vs. passive investment management. Some commentators have suggested that index-oriented investments are merely for “dumb” investors, who have no real skills in picking mispriced securities likely to outperm the market. If this were to be true, it would follow that these investors are leaving money on the table as by either investing in the development of these skills – or hiring talented active managers – they could produce better returns. It has been suggested that over the very long run, “sensible investing” in “quality” stocks “will beat an index”. How true is this? (spoiler alert: the evidence suggests this is not true!). For more click the link: (VIEW LINK)

Patrick Poke

I'm having trouble commenting on your site (not sure if it's worked or not), so I've copied my comment here also: Interesting article David, and I agree on most points, though not all. You said: "Even if active managers were able to consistently outperform the market, moreover, their degree of outperformance would need to exceed their management fees to beat some of the very low cost ETFs and index funds available. As but one example, a fund that charged a 1% p.a. management fee plus a 10% outperformance fee would need to generate a return of 10.95% p.a. to offer the same return to an investor in an index product that rose by 10% in the year and charged a management fee of 0.15% p.a." Unless you're quoting before-fee returns (which would be very strange) in your table, this would not be true. Most managers in Australia quote their returns after fees - in fact it is the fees that usually drag the 'average' managers to below-market returns. You've also looked at the 3 year returns, I don't think that 3 years is anywhere near long enough a time period to be looking at. 5 years is an absolute minimum to get any indication, and Fama and French have suggested that to get a reliable indication you need longer than this. I think we can both agree however, that there are active managers who can consistently outperform the index (as Warren Buffet taught us with his Superinvestors of Graham and Doddsville speech in '84), the difficult part is identifying in advance who they might be! Past returns are not a good indicator, but other factors could be. Some of the factors which I think show potential (though their reliability is questionable, and I think they need further investigation) include 'active share', portfolio concentration, value bias, small-cap bias, and portfolio turnover. I've seen research on each one of these factors which suggests that in isolation they are indicative of the potential to outperform (of course a 'closet index' fund is never going to outperform, especially after fees), however they cannot be relied upon to predict fund performance. Many of the fund managers with highly concentrated portfolios and high active share are just as likely to underperform.My own expectation is that, when multiple boxes are ticked, one may be able to produce a more reliable indicator of fund performance. Of course this is just my hypothesis at this stage, I hope to do some proper research on the subject in the final year of my Master's degree.

David Bassanese

Thanks for your comments and passing on your research finding. As you say I am sure there are a few fundies that can outperform over time.and a few strategies they seem to work . but finding them and sticking with them is hard as even they may go through periods of under performance. In general, everyone can't beat the market! Cheers David