One of the world’s biggest and most respected market analysts has confessed that the best investment advice ever is not what most people think.
Despite offering reams of statistics and analysis dating back over decades, the experts at US firm Standard & Poor’s say the best advice they can give is investors should work on the assumption that no one knows what will happen next.
Although retrospective analysis shows what lessons history can give investors, S&P says the only other certainty is a pattern that has lasted for more than 80 years.
And that is investors who base their portfolios on index funds outperform active managers over time.
The advice is not to try and outguess the market by buying low and selling high because the strategy rarely works over the long term.
“Since we don’t know which styles or managers will be in favour next quarter or next year, how should investors manage their agnosticism? If we can’t know the future, we can at least rely on historical patterns of behaviour,” said Craig Lazzara, managing director and global head of index investment strategy at S&P Dow Jones Indices.
“One such pattern, with a pedigree of more than eight decades, is the observation that most active managers underperform passive benchmarks.
“There are good theoretical reasons why this should be true, stemming most convincingly from the zero-sum nature of professional investment management.
Active or tracker debate
“If I’m to be above average, someone else must be below average, and the weighted sum of the winner’s outperformance is exactly equal to the weighted sum of the loser’s underperformance — before costs. The incremental costs of active management place active investors, as a group, at a permanent disadvantage relative to their passive competitors.”
S&P’s latest data shows 43% of US equity fund managers outperformed the S&P 500 in the year to the end of June – and the stats worsen when the time horizon is stretched over three or five years.
In the UK, the figure is only 28% for active equity funds.
“We don’t know what will happen next year; we don’t know which active managers will outperform and which will fail. What we do know is that investors who put index funds at the core of their portfolios have outperformed most active managers most of the time. Investors who act accordingly have the odds on their side,” said Lazzara.