Most active fund managers struggle to beat the market…again

Two separate reports. Two separate markets.

The results?

The same.

According to Morningstar research, only 36% of the 450+ actively managed large cap funds met or outperformed the S&P/ASX 200 Accumulation Index over the five years to August 31. In other words, two-thirds or most large cap fund managers can’t beat the index.

It’s yet another sorry indictment for active fund managers that charge large management and performance fees and then fail to beat the index they are tracking. When index funds charge a fee of around 15 basis points (0.15%) to closely match the index, one wonders why investors still allow active fund managers to get away with charging management fees of 1% or even more, plus performance fees if or when they beat the index.

The US is worse

In the US, the results are even starker. Morningstar reports that just 9.5% of actively managed large cap equity funds managed to beat the S&P 500 index in the five years ending August 31.

And a report by S&P Dow Jones Indices revealed that 85% of large cap funds, 88% of mid-cap funds and 89% of small cap funds failed to match their respective stock indices for the 12 months to end of June and the numbers for five and ten years were even slightly worse.

In the US, investors have been starting to take notice. Around 3,000 actively run funds saw fund outflows of US$422 billion in the period, while passive (index tracking funds) saw inflows of US$480 billion.

Large cap problems

Australia’s fund managers need to start paying attention, because our market is highly likely to follow the lead of the US. Active fund managers may blame the efficiency of the market – particularly in the large cap space. Australia’s concentrated market with the top 20 stocks representing virtually half the market make it difficult for the larger fund managers to outperform given they virtually have no choice but to invest most of their funds in the top 20 stocks.

But as the saying goes, “if you can’t stand the heat, get out of the fire”. Large cap fund managers that can’t beat the market should really give the game up and hand the cash back to investors and suggest they invest in an index fund or exchange traded fund (ETF). They won’t of course – because of the fees they are raking in.

One fund manager that is struggling is Perpetual Limited (ASX: PPT). A number of its funds are ranked in the third or fourth quartiles over one year. In other words, those funds are near the bottom when it comes to performance – and most likely underperforming the relevant indexes. Most of its funds charge management fees of around 2% too – likely a factor in its underperformance.

Platinum Asset Management Limited (ASX: PTM) has also had its share of issues, with funds under management heading out the door due to poor recent performance.

Small cap fund managers the go?

The key for investors is to either find those select few fund managers that can trounce the market consistently over longer periods of time, or simply put their funds into a low cost index fund or ETF.

In Australia, almost all the actively managed small cap fund managers have beaten the market over five years according to Morningstar. There’s the first place for investors to look for actively managed funds that have a strong chance of beating the market.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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