Nine In Ten UK Equity Fund Managers Beat Index: How?

Nine In Ten UK Equity Fund Managers Beat Index: How?
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While US equity markets stole the show last year, it was UK equity fund managers who had the best performance with nearly 90% of them outperforming the FTSE 100, reports Chris Flood at the Financial Times. While some active managers were eager to seize on this as proof that they have more to offer than low cost, passive ETFs, it’s more likely a fluke of the FTSE’s top heavy market caps.

FTSE index dominated by a few struggling giants in recent years

“UK active managers have done a good job in recent years. The S&P data show that there are more effective investment strategies available than buying a passive UK tracker,” said Schroders head of European equities Rory Bateman, Flood reports.

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But the index results have been dominated by the three largest companies by market cap, Royal Dutch Shell plc (NYSE:RDS.A), HSBC Holdings plc (NYSE:HSBC), and BP Plc (NYSE:BP), which all had weak performance in the years up to the end of 2013. Any UK manager that was underweight on a handful of struggling mega-caps was likely to beat the FTSE 100, and it appears that group includes quite a few managers.

That’s not to say that there aren’t any talented stock pickers in the UK. But unless you think that UK managers have some sort of systemic edge of their European counterparts, who underperformed their respective indexes by 60% in 2013, then you have to expect their performance to return to the mean over a longer timeframe. And once that happens, experience tells us that most of them will underperform passive ETFs once you take fees into account.

Individual investors tend to overemphasize recent performance

Hopefully most people will see this for the outlier that it is, but individual investors do have a bad habit of moving in on a new stock/fund/asset class when it is hot and then pull out at the first sign of trouble. Whether that translates as buying stocks high and selling them low, getting the worst out of a mutual fund by moving money in and out at exactly the wrong times, investors are usually their own worst enemy.

Ironically, investors’ tendency to favor the home markets to the near exclusion of foreign equities, another bias that usually hurts returns, probably means that we won’t see a flood of reallocations from German to British fund managers, for example.

H/T Brendan Conway of Barron’s 

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