Many investors are searching for the quantifiable "crystal ball" that will enable them to identify talented investment fund managers in advance.
However, a recently-released and updated research paper from Vanguard in the US notes that while investors undertake their ongoing search for the perfect silver bullet, many overlook a "very good metric" to increase their chances of success.
This research, Keys to improving the odds of active management success – by Vanguard investment strategists Daniel Wallick, Brian Wimmer and James Balsamo – confirms yet again the critical importance of low cost to investment success.
"A fund’s current expense ratio – a simple and readily available figure – has historically proven to be an effective predictor of relative future fund performance," Wallick, Wimmer and Balsamo write
In June this year, Vanguard in Australia released a comprehensive edition of this research paper, analysing local performance data as well as providing additional analysis by Alexis Gray, an economist with Vanguard’s investment strategy group in Australia.
These papers emphasise that the influence of low costs on future performance intuitively makes sense. This is because an investor’s return is decreased by every dollar spent on investment-related costs.
And while indexing is synonymous with low cost in the eyes of many investors, historic data [set out in detail in both papers] shows a "more nuanced reality". That reality is that low cost can improve an investor’s odds of success with both active and indexed funds.
Although Vanguard is widely recognised as a global leader in indexing, globally it has almost US$1 trillion in actively managed funds, US$420 billion of which is in active equity funds.
It is not a case of an investor having index or active management to the exclusion of the other. Indeed, many investors who clearly recognise the powerful case for index funds often still find a place in their carefully-constructed portfolios for some favoured actively-managed funds.
Both Vanguard research papers include these points:
- On average, most active managers have lagged their benchmarks. And active managers only rarely have outperformed their benchmarks over the long term.
- Investors should only invest in actively managed funds if they have the patience to "withstand what could be extensive periods of underperformance".
No matter your investment style, low cost, patience and a long-term perspective really matter.
Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia.
As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment.