Financial Times

Internet Trader - Fund managers and pond life

By Alpesh B Patel: 9 November 2001 DON'T LET supermarket hype blind you to the lack of skills and the poor performance record of fund managers.

They're supposedly the best equipped to manage your funds. Billions of dollars are entrusted to them, and they have global resources at their disposal. So should you assign some of your money to fund managers?

After all, there's been a recent proliferation of fund supermarkets. The hearings of the case brought by Unilever's pension fund against Merrill Lynch's Mercury Asset Management subsidiary alleging fund manager negligence because of underperformance are now in their third week in court.

If Unilever can be so unhappy, what hope has an online trader, even with novel online tools, of picking a good fund manager?

Not much, according to ample evidence. "The deeper one delves, the worse things look for actively managed funds; 99 per cent of fund managers demonstrate no evidence of skill whatsoever," says William Bernstein in a study of the fund industry published this year.

Investment legend Peter Lynch in Beating the Street confirms: "All the time and effort people devote to picking the right fund, the hot hand, the great manager, have in most cases led to no advantage."

Warren Buffett in his 1996 letter to his Berkshire Hathaway shareholders advocated recourse to a passive index tracker rather than fund managers: "The best way to own stocks is through an index fund . . ."

But the strongest argument against trying to pick a fund manager is performance. Only nine of 355 funds analysed by Lipper and Vanguard beat their market benchmarks from 1970 to 1999. Analysis by http://www.ifa.com/ of the Morningstar database of equity funds found "no discernible pattern of persistence in superior manager performance."

What about picking the best performers using tables? Unfortunately, all the top 10 performing funds in any year drop from 1st place to nearly last place among all funds within two to four years, according to a 26-year study by the Dalbar rankings agency.

Updated in 2001, the study found that from 1984 to 2000, the average stock fund investor earned returns of only 5.23 per cent a year while the S&P 500 returned 16.29 per cent.

Yet in spite of this, 75 per cent of mutual fund inflows follow last years "winners", according to fund researcher www.morningstar.com. And Lipper Europe www.lipper.com confidently claims that European fund assets will grow to more than $10,000bn before 2010 from the current $3,000bn.

Even Nobel laureates agree on the hopelessness of picking top performing fund managers. Prizewinner Merton Miller observed in a documentary last year about funds: "If there's 10,000 people looking at the stocks and trying to pick winners, one in 10,000 is going to score, by chance alone, a great coup, and that's all that's going on. It's a game, it's a chance operation, and people think they are doing something purposeful . . . but they're really not."

All is not lost for fund investors. Research published last month by Jay Kaeppel of eCharts.com indicates that a simple fund investing strategy can be lucrative.

By buying at the start of each month the top five best performing sector funds of the past 240 days, and then starting over again the subsequent month, he turned $50,000 invested on the last day of 1989 to $692,384 by December 31 last year; an annual 27 per cent rate of return. He used Fidelity's Sector funds. Of course this is a ridiculously simple test and only goes back to 1989.

So what is to be done? If fund managers can't beat market benchmarks, then we could invest in index trackers and be assured of at least matching the benchmarks.

If only it was that easy. Tracker funds can diverge from the index they're tracking by up to 30 per cent according to a survey last month by Chartwell Investment Management. For tracking the FTSE 100 they recommend the Prudential UK Index Tracker Trust.

Meanwhile, what about Unilever and MAM? With so much evidence about poor fund manager returns, little wonder that no pension fund has ever before tried to claim negligence against a fund manager for under-performance. After all, the fund managers could turn around and say: "What did you expect?"

The Intelligent Asset Allocator, William Bernstein, (McGraw-Hill 2001); Beating the Street, Peter Lynch with John Rothchild (Simon & Schuster 1994).