Most funds aim to track and/or outperform a “benchmark” index. For example, an Australian equities fund may be benchmarked against the S&P/ASX200 index. The reality is, a majority of fund managers don't beat their benchmark index, and here’s two reasons why:
- Fees - Fees and the brokerage costs associated with active management reduce returns. So, a fund manger doesn't just need to beat their index, they need to beat their index plus these fees and costs. A managed fund for example benchmarked against the ASX 200, cannot simply invest in each of the 200 stocks comprising the ASX 200, because to do so would guarantee they under-perform the index by the sum of their transaction costs and management fees. Therefore, a fund manager can only beat their benchmark index, if they can find the winners within the index and keep transactions at a minimum.
- Finding the winners - The internet has made the sharing of information across the globe instantaneous. Fund managers, who pick up a trend early, can outperform for a short period of time, until other fund managers follow suit and bid-up the price of the security to a level that is no longer considered to be good value. Securities within an index that are outperforming the overall index, such as a small cap company, are closely watched. In larger capitalised stocks or liquid securities such as commodities, it is even harder to find underpriced securities because nearly all fund managers around the world will be watching. If fund managers are not picking up trends on qualitative analysis, then the new breed of high-speed trading systems will pounce on anything underpriced due to quantitative metrics. It's almost impossible to continually pick the winners, and if you do, they're unlikely to be winners for long.
Logically, and mathematically, it is near impossible for a fund manager to outperform their benchmark index consistently over time. So why pay higher fees for actively managed funds when you can simply invest in a low cost index fund such as the InvestSMART Diversified Portfolios?
These portfolios are made up of index funds or ETFs (exchange traded funds). The portfolios invest in a range of asset classes that have been matched to risk profiles, meaning investors can access global diversified portfolios that are matched to their own risk profile, for instance "Conservative", “Balanced”, "Growth" or "High Growth".
Australia and Asia have been slow in catching onto index funds or ETFs. In the U.S. (as of June 2014) exchange-traded products (ETPs) accounted for more than 70% of global assets while Asia contributed just 7%, according to a BlackRock ETP Landscape report. However a Price Waterhouse Coopers report, released in January 2015, predicts global assets held in ETFs will almost double from US$2.6 trillion in August 2014 to US$5 trillion by 2020, and Asia is expected to “contribute significantly” to this outcome.
Click here to find out more about the InvestSMART Diversified Portfolios.