Paul's Insights: Is it really possible to beat the market?

Following the market mayhem we saw in March, Australian shares have notched up gains of 13.75% over the last quarter^[1]. And after a massive spike in sharemarket activity through March, investors are settling down to a more regular pattern of trading.

Over 67 million share trades were made during March^[2], almost double the normal volume. It’s a no-brainer that this would have been driven chiefly by investors bailing out of shares. But as investors climb back in to the market, exchange traded funds (ETFs) are proving very popular.

The appeal of ETFs is that you get immediate diversity – across different shares, sectors and even geographic regions, backed by very low fees.  Many ETFs are index funds. This means they aim to replicate the performance of a particular market index, like say, the ASX 200. It’s a very different approach from actively managed share funds, which typically aim to outperform the market by picking stocks that will deliver healthy gains. It is the passive approach of index funds that helps to keep their fees so low.

Some investors aren’t comfortable with simply accepting whatever returns an index or index fund dishes up. That’s fair enough. The idea of beating the market is always appealing. The problem is that it is extremely hard to do consistently.

As a guide, the SPIVA Scorecard tracks how well actively managed funds outperform the market over time. The latest SPIVA Scorecard[3] for Australia shows that over the five years to December 2019, only 19% of actively managed share funds achieved above-market returns. Eight out of ten failed to beat the market.

The winning streaks enjoyed by actively managed funds are often short-lived. Research by S&P Global[4] tracked the performance of the top 25% (by returns) of actively managed funds in 2015. Out of the top-performing funds, only 1.7% consistently beat the market over the following four years.

For investors, this shows how low the odds are of picking an actively managed fund that consistently tops market returns. In periods of extreme volatility, it is even harder to beat the market. Yet investors pay fund fees regardless of whether their fund has dished up gains or losses.

This highlights why ETFs have become so popular among Aussie investors. Sure, not all ETFs are passively managed index funds, but the common thread is very low fees. That matters because outperforming the market year after year is exceptionally difficult. Taking control of the cost of your investments is a lot easier to do.

Learn more about InvestSMART's Capped Fee Portfolios here.

Paul Clitheroe is Chairman of InvestSMART, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.

[1] https://au.spindices.com/indices/equity/sp-asx-200

[2] https://www.asx.com.au/asx/statistics/tradingVolumes.do

[3] https://au.spindices.com/spiva/#/reports

[4] Persistence of Australian Active Funds, December 2019