Active Investors Are Desperate For The Jackpot

Let’s be honest, there can’t be many of us who haven’t thought about how we might spend a lottery jackpot win. As a journalist, I’ve asked several overnight-multi-millionaires over the years how their success would change their lives; I’ve probably wondered more than most how instant wealth would impact on mine.

How lottery organisers must love the photo opportunities those cheque presentations provide. They must lick their lips at the publicity the really big winners tend to generate and, of course, at the increased ticket sales and profits that inevitably ensue.

Camelot, the company that runs the UK’s National Lottery, has recently increased the number of balls in the bucket from 49 to 59, which means your chances of landing the jackpot are now even slimmer than they were. The odds of matching six numbers from 59 are one in 45,057,474.

Active Funds – Better Chances, But Still Slim

The good news for investors is that the odds of choosing an actively managed fund — or portfolio of active funds — that will beat the market over the long term are rather better than that. But the data suggests that it’s far more of a long shot than the industry’s seductive PR and advertising tends to imply.

People starting to save for retirement today will typically need to invest for a period of 40 years or more. But the chances of simply choosing a fund that will still be around 40 years from now is tiny. For fund houses, the oldest trick in the book is either to close an underperforming fund or merge it with another fund.

The research organisation Lipper recently showed that the average life span for a UK-domiciled fund is just ten years. Of the 2,991 funds active that were trading at the end of September 2005, 1,096 were either liquidated (635) or have merged (461). Only 52 percent of them are still trading in their own right.

In some sectors, the proportion of funds that survive even that long is lower still. For instance, S&P Dow Jones says just percent of UK large- and mid-cap equity funds have survived the last ten years. If just four in ten funds manage to last ten years, you’d be very fortunate to pick one that lasts for 40.

What Are The Odds For Outperformance?

But say you do strike lucky and choose a fund that will still be trading in 2055. What are the chances of that fund outperforming the index over the intervening 40 years? Again, they are extremely slim. According to the newly-published SPIVA Europe Scorecard, which measures the performance of actively managed funds against their benchmarks, 89 percent of global funds and 91 percent of U.S. equity funds have failed to beat the market over the last five years. Over ten years, the figures are worse still. Given those statistics, it will be no surprise if not a single fund in those two sectors outperforms over a full 40 years.

I’ve written many times before about how unaware consumers, and even many advisers and investment journalists, are about the long-term impact of fees and charges on the investment returns of active investors. But new research from the Universities of Chicago and Oxford suggests that the cost of the inherently high chance of underperformance is even higher.

Think about it. At least with the lottery you either win (albeit at odds of more than 45 million-to-one) or you don’t win. With active investing there is a very real danger that you could lose big-time. Remember, active management is a zero-sum game. An active manager can only win at another manager’s expense. Woe betide if that other manager happens to be yours.

Not A Worthy Cause

And another thing. At least if you don’t win the lottery you can draw some comfort from the fact that at least part of your losing stake will go to good causes. Since 1994, the UK Lottery has issued 450,000 grants to mainly worthy recipients. Our new village hall, for example, would never have been built without the proceeds from hundreds of thousands of losing lottery tickets.

By taking a punt on an active fund, on the other hand, you’re helping to support an industry that last year made profits of $102 billion and whose pay packages for senior staff are now on a par with investment banking. One City of London manager, M&G’s Richard Woolnough, earns around £17.5 million a year — about 600 times the average UK salary.

Sorry, Mr Woolnough, I don’t care how skilled (or lucky) you are. You’re not my idea of a worthy cause.

Robin Powell is a journalist campaigning for a better deal for ordinary investors. He blogs as The Evidence-Based Investor.