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Anthony Hilton: Active fund managers have abandoned the long term

17 January 2019

he fund management industry produces the wrong outcomes for the wrong people. But those who run the business, particularly the active managers, make far too much money to change it.

A third of the industry is in tracker funds. Clients think they will replicate a share index and probably they will. There are, after all, more indexes than there are quoted shares! But what does that mean?

Hendrik Bessembinder, a professor at Arizona State University, wrote two years ago that 96% of shares do no better then Treasury bonds, and Treasury bonds are a lot less trouble.

To come up with his findings he calculated every single stock in the index for 90 years from 1926 to 2016. Only 1% of shares, of the 26,000 he looked at, made phenomenal money, and 3% did okay. The rest you could forget.

Now tracker funds charge clients next to nothing, which the client thinks is a good deal, and in many ways it is.

Most trackers actually make their money by stock lending, of which the client is often unaware. Stock lending is an integral part of the process of shorting stocks — helping a stock to go down. People with trackers probably don’t know this.

Tracker fund managers are agnostic about the shares they hold. Today’s tracker funds also probably host the likes of fossil fuels stocks, pharmaceuticals, and High Street banks.

These are huge businesses, but the chances are they are all going to fade and die over the next 20 years or so, due to climate change, gene therapies and financial disruption.

For a lot of that time, though, they will still be in the index and be a drag on performance.

But many so-called active share managers are certainly no better, often a lot worse, and they charge more.

Most have long since given up on actually buying good stocks for the long term and encouraging the management to invest for the future.

Instead they second-guess other managers, trying to pick a stock a few days before everyone else buys it, hold it for a few months or less, and then do it all again. Thus they trade incessantly.

On Wall Street the turnover of shares, thanks to computer trading, has gone from two months in 2008 to 20 seconds now.

That is the average time a share is held in total… 20 seconds.

Also, only about 10% of the market is bought by discretionary fund managers in the old-fashioned way.

Instead most strategies are quant and computer driven, looking for price movements but with no understanding of the company, what it does, or why anyone should care. The British market is the same.

There are good active managers out there, but only a few do genuine long-term investment. The others are in houses where the focus is on short-term earnings.

But one of the good guys, Stuart Dunbar of Baillie Gifford, says those who still look for good companies and encourage long termism have to stand up and make their case because many so-called active managers are failing their clients.

“Too much of what passes for active management is simply second-order trading of existing assets, with the main focus being to try to anticipate the behaviour of other investors. This has little to do with actual investing and creates huge amounts of overtrading and volatility,” he says.

“Most investing is no longer about making long-term risks in definable investment projects. It is more about free riding on the mythical ‘market return’ at minimum cost; participating in an expensive zero-sum arms race of better, faster, smarter analysis of markets with the actual companies nowhere in sight; shuffling risks around through financial engineering disguised as value creation; and about confounding and confusing on costs which are often not justified by managers who have lost sight of their core purpose.”

There is more. Dunbar adds that the industry creates structures to measure itself and report on quarterly or annual performance against benchmarks; some investment managers are incentivised on short time periods or even assets under management, while the task of educating clients is ducked.

He says: “It also serves no useful purpose other than for those who make a very handsome living from transitional activity or those who confuse their clients into thinking that short-term volatility is a skill.

“Everybody is trying to outsmart everyone else by buying and selling existing assets… It has little to do with wealth creation either for our clients or society.”

Dunbar is surely right and Scottish Mortgage Investment Trust, one of the FTSE 100 stocks managed by the firm, is testament to that vision. Would that there were more.