I had the pleasure of listening to a talk from Dr Michael Mosley recently. I confess that I had seen his maverick TV documentaries involving self-experimentation but had not realised how his work had had such a positive impact on the medical world.
In 1984, he was working as a producer and credits an Australian doctor as the inspiration for him stepping in front of the camera as a presenter. He was filming Professor Barry Marshall who was convinced that stomach ulcers are caused by an organism called Helicobacter pylori rather than stress. Sadly, no one would believe him and his views were largely ridiculed at the time. He decided to swallow some of the bacteria and induced gastritis. This was treated with antibiotics and he was able to prove that ulcers are not an incurable disease. Following the film’s release, Barry went on to win the Nobel Prize for medicine.
Many historical discoveries have been made by challenging preconceived ideas and not just in medicine. The most innovative scientific findings have gone against people’s existing beliefs since the history of time.
Back in the 60s and 70s, active asset management – where a professional fund manager uses his judgment to guess which assets will perform better than average – was the norm. Clients paid substantial fees for investment managers to deliver returns on their portfolios.
However, numerous academic studies, not least conducted by the likes of fellow Nobel Prize winner Professor Eugene Fama, have shown over the last few decades that active asset management is unlikely to provide adequate returns after costs over the long term. Eugene developed the Efficient Market Hypothesis which purports that trying to beat the return of the market is futile.
Instead, he found that a passive portfolio, which is designed to track an index, market or asset class with significantly lower costs and turnover, makes very good sense.
Over the last ten years, 83 per cent of active funds in the US have failed to match their chosen benchmarks. From this, some 40 per cent of funds collapsed before the decade finished. In 2016 in the UK, asset managers suffered their worst year since the start of the financial crisis with just 21 per cent beating the market.
This month we heard that Baillie Gifford, one of the UK’s top-performing asset managers, has seen outflows from its pension fund clients of ten per cent per year as they switch to lower-cost passive funds. The firm is no longer receiving enough inflows from investors to make up the shortfall. In the last two years, Baillie Gifford suffered a net outflow of pension fund assets of £9.2bn.
As financial author and investment consultant Charles Ellis wrote in his FT article ‘The end of active investing’, “Since index funds deliver the market rate of return through a widely diversified portfolio with no more than the market level of risk, the only justification for actively managed funds must be either more returns or less risk or both — increasingly recognised as the investment world’s version of the triumph of hope over experience.”