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Investing: Accumulation not speculation .

Previously, I wrote about how difficult it is for any investment manager to consistently outperform the market over the long term.
Below I detail how active funds rarely add value in a consistent manner to a client portfolio and what other factors should be considered.

About the author

+44 (0)20 7556 1379
horowitzd@buzzacott.co.uk

In 2008, legendary investor Warren Buffett took a $1 million wager that investing in a ‘passive’ index fund would result in greater returns than if you entrusted it to the active management approach of hedge fund managers. Buffett won, big time. His pick - the S&P 500 index, increased in value by 125.8% over ten years. The five hedge funds only added an average value of about 36%.   

A result such as this would certainly not have come as a surprise to Eugene Fama, 2013 Nobel Laureate in Economic Sciences. His view on actively managed funds is unequivocal and sobering:  “If you want to get poor quickly, you should go into them [actively managed funds].”

Much has been written about the comparative performance of index funds in relation to active funds. Outperformance of index funds is typically talked about in strong “bull” markets. However, active managers will pitch their approach as offering strategic protection in a downturn. 

We believe that a passive management approach can be suitable in all markets. An analysis of the US markets between 2004 and 2018 complied by Dimensional Fund Advisors [1] echoed this sentiment (see graph below). Their research shows that the majority of active managers do not outperform in any market conditions. As such, whether the market is going up or down, a passive approach represents better value for an investor.

DimensionalFundAdvisorsgraph

 

What does Buzzacott do differently?

Buzzacott’s approach to investing, relies heavily on the analysis and evidence from Nobel Prize winning research. 

Rather than attempting to predict the future or outguess others, we draw information about expected returns from the market itself. The construction of our investment portfolios is guided by six key beliefs which are backed by decades of empirical research summarised below: 

Embrace passive management – The market is almost impossible to beat on a consistent basis and the majority that try, will fail. While investment managers will extol the virtues of their stock picking ability, evidence indicates this does not add value over the long term.

Concentrate on Asset Allocation – Some studies attribute up to 100% [2 ] of a portfolio’s performance characteristics to asset allocation. Finding the right mix between stocks, bonds, property and cash has been proven to be crucial to investment success. As such, we spend our time concentrating on this rather than whether Tesco is a better stock than Morrisons! 

The asymmetry of risk and return – All investors would like guaranteed high returns while taking low risk. Risk and return is largely, although not always, symmetrical. This means, the higher the return required to achieve your financial planning objectives, the higher the weighting to more volatile assets. 

Do not put all your eggs in one basket - In theory, your investments would consist of one asset class – the best performing one! However, it is impossible to reliably predict or time performance in advance. Therefore, taking a diversified approach which means spreading your investments around as much as possible is a simple and sensible way of reducing risk

Control Your Cost Base - Cost is identifiable, whereby performance is not. We focus on the former and aspire to the latter. Research undertaken by Morningstar into their own star fund performance rating system indicates that a fund’s expense ratio is a more reliable predictor of future outperformance than the fund’s past performance record. Put another way, lower cost funds are more likely to be higher performing funds. 

Remain Disciplined – It is the role of your advisor to keep you rational in an irrational world. Buying high and selling low sounds risky, but surprisingly, it’s what lots of people do. Buzzacott concentrate on the long term and seek to remove the emotion from investing. 

 

Financial Planning at the heart of your investment strategy

We don’t think the investment tail should wag the financial planning dog! Rather we strongly believe that our clients should have a robust financial plan before investing. That’s why our clients benefit from our “Integrated Wealth Management Service”. 

We work with you to understand the objective and rationale behind any investment you might make. This way, we can ensure that it is both tax optimised, while taking the level of risk that is appropriate to achieve your goals. In short, we look to understand ‘why’ you are making the investment to better inform ‘what’ the investment should be.

Our approach is to look at all parts of the jigsaw and bring it all together. You, your financial objectives and the part your investment portfolio should play in this. 

Rather than our clients just having an investment portfolio, they also benefit from a plan that covers how to manage risk, structure their investments, how to remain tax efficient and how to future proof your portfolio.

 

[1] US Equity mutual fund outperformance percentages are shown for the three-year periods ending December 31 of each year, 2004–2018. Each sample includes equity funds available at the beginning of the three-year period. Outperformers are funds with return observations for every month of the three-year period whose cumulative net return over the period exceeded that of their respective Morningstar category index as at the start of the period. US-domiciled non-Dimensional mutual fund data is from Morningstar. Dimensional fund data provided by the fund accountant.

[2] Ibbotson – The Importance of Asset Allocation, Financial Analysts Journal Vol 66, Number 2 (2010)

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