Behind the Wizard’s Curtain- why the financial media’s claims can’t always be trusted
This article was published in June 2023
These aphorisms highlight a simple but important truth that is more relevant and profound today than ever:
“Facts are stubborn things, but statistics are pliable.”
Mark Twain
“Statistics do not speak for themselves.”
Milton Freedman
These days the sheer abundance of data and information available to us can be dizzying and overwhelming. How then do we make sense of the world around us? As we always have. With stories.
In this age of free-flowing information, different stories can present themselves any way you turn. If not outright fake news, it is astonishing how the same facts can be used to form completely different narratives, or how seemingly hard numbers in research and the media can be misconstrued. It is therefore, as ever, important to act with judgement and consideration of the stories we hear, and to be aware of the underlying belief, message or agenda. And that assumes the true story has been correctly understood:
Good examples of how seemingly hard numbers can be unfounded or misrepresented be found in ‘More or Less’, which looks behind some of the numbers in life and the news, and asks what’s really behind them, often yielding surprising results. It is available in podcast form here, as well as other podcast sites and apps. Reuters also have a useful factchecking service here.
Unfortunately, the world of investing is no stranger to the interpretation and presentation of statistics which can potentially be misleading if one is not careful. Just one example of this is a recent piece of research by a fund management firm that manages a considerable US $580 billion1. In other words, they should know far better.
In their first edition of their 2023 ‘PassiveWatch’ study (now redrafted after backlash from others in the industry), Columbia Threadneedle (CT) made a bold conclusion:
“Performance of active funds beat passive in every market in the UK over a 20-year period”.
Before investing based on claims like this, it is best to look under the bonnet and see where they actually come from. It is not long before the study reveals some very basic limitations.
To form this claim, CT have only compared the best performing active funds in the UK category with their passive counterparts. From a practical perspective, this comparison is essentially meaningless. With hindsight, it is extremely easy to pick the best performing managers and then show those managers outperforming their index. However, investors do not benefit from hindsight when choosing which investment to make now.
Where passive funds generally look to buy an index, active funds try to beat it. To achieve this, they must deviate from the market’s basket of assets. For this reason, the returns of active funds will be less aligned with the market (the ‘index’ as shown by the above bar chart) than passive funds tend to be. It is no surprise then, that one or a few active funds will outperform both passive funds and the index. For each active manager winning, there is, by definition, one manager losing the ‘bet’.
If a passive fund aims to track the index, and the index is, by definition, the aggregation of all trades in the market (all winners and losers), then asking if the best active managers (with the benefit of hindsight) outperformed, then the answer is obviously ‘yes’, again by defintion. It is one of the defined axioms of the argument and a trivial proof. If you define A as greater than B, then it follows that B is less than A. Nothing has been unveiled.
This is not, however, a good argument for active investing. Achieving the returns used in CT’s calculations means choosing the right fund out of hundreds of potential candidates, and sticking with it for 20 years. Alan Miller of SCM Direct sums it up:
“It’s a bit like saying you’re better off buying a lottery ticket than putting your money in the bank because had you won the lottery each year, you’d have done much better.”
Even in their own research, seen above, CT shows that in five out of the six categories they measure, there is only one where the average passive fund does not beat the average fund, and even when it does (Equity Europe ex UK), the difference is just 3 percentage points over 20 years.
In the sector that CT themselves highlighted, the study showed the average fund made 262% over the 20-year period, compared with 299% from the average passive.
A reputable study2, on average across the eight categories of funds denominated in GBP (so a similar fund set to the research above), 80% of active funds failed to deliver on their promise of beating their market benchmark over 10-years. For a 20-year period this is more than likely to be higher.
The study also shows that the amount of active funds that failed to survive in the 20 years investigated. reveals that only around 50% of GBP-denominated funds survived the 10-year period to the end of 2022. Over 20 years, this figure will be even worse. The funds that didn’t make it are likely to have been poor performers. If these were included in the average return for active funds. It is likely that their underperformance compared to passive would be even worse.
Granted, active funds do have a chance of outperforming, but the majority tend to underperform, and some can even give negative returns while the market is climbing. Picking a winner and survivor in advance is more luck than judgement on the part of the investor. The majority will end up paying more for a product that returns less. This is indicated by the study’s own data.
Although CT removed their claim after being called out by other professionals, it is best not to do research by using to organisations who have skin in the game. Organisations like the S&P provide a multi-year data set that tells it’s own story through their annually available S&P Indices Versus Active (SPIVA) research found here.
The proponents of active management make a lot of money from selling active funds, which are generally more expensive than their passive counterparts. Perhaps they are not the best organisations to listen to when choosing what to invest in. With investing, as for all news, it is best to identify if the source in question is trying to convince you of something, and ask whether those that produced it stand to benefit from convincing you.
Misleading information can be hard to identify, but properly researched empirical evidence is what we rely on to reveal the truth and inform how we look after client money.
Financial planning is not built on trying to find the best investment over any given period of time. It is about constructing a portfolio that reliably returns what it needs to achieve an investor’s goals and then deploying a disciplined strategy to capture those returns.
Risk Warnings
This article is distributed for educational purposes for UK residents. It should not be considered investment advice, an offer of any security for sale nor a recommendation of any particular security, strategy, platform or investment product. This article contains the opinions of the author but not necessarily the Firm. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.
[1] As reported in https://www.trustnet.com/News/13368133/columbia-threadneedle-says-active-funds-beat-passives-in-every-market–do-its-claims-stack-up/
[2] SPIVA Europe Year-End 2022 Report https://www.spglobal.com/spdji/en/documents/spiva/spiva-europe-year-end-2022.pdf
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