It may come as no surprise to anyone who follows us, but just in case you forgot, we don’t think too highly of active management. It is nothing personal, of course. The fact of the matter is that the vast majority is not delivering on their proposed value proposition to investors. The “we can beat the market” approach to investing is slowly becoming as relevant as VCRs.
Most of the recent merit of active investing is based purely on random outcomes. It is just an illusion built on a rocky foundation of small sample sizes and bad benchmarking. Nonetheless, misinformation and financial illiteracy by the masses continue to feed the active management community its morning breakfast. Hence, we find purpose in waking up everyday to make sure that breakfast has a nice helping of humility.
We recently came across “The Gurudex,” a tracker of the market predictions made by 16 of the largest and well-known financial institutions in the world. Some of the names include Barclays, J.P. Morgan, Credit Suisse, Goldman Sachs, and Merrill Lynch. These financial heavyweights make a lot of money telling people what they think is going to happen in the marketplace. They are white collar “soothsayers.”
The Gurudex shows the predictive accuracy for each institution across multiple time periods. For example, as of today, Barclays has been 74% accurate in its market predictions over the last 30 days. Not bad at all! Many investors may believe this as being proof of displayed “skill.”
The reality is that investors don’t have time horizons of just 30 days, so besides it being a small sample to base conclusions off of, it is also irrelevant in a practical sense. Once we expand the view out to, let’s say, the entire year of 2015 we see a completely different picture. The average prediction across all 16 was 41% for the year; less than accuracy of a fair coin with the most accurate firm being Nomura Securities International, coming in with a whopping 60% accuracy rating. In other words, you could have just stuck with good ole’ George Washington to make your predictions for you and would have been expected to do better than the “experts.” One costs you $0.25 and the other upwards of 2% of your entire asset base.
The Gurudex also allows you to see how you would have done if you followed the collective wisdom of the “experts” in terms of stock predictions versus the S&P 500 or simple savings account earning 3% interest under the “Big Picture” tab. In 2015, investors would have lost -4.79% versus -0.69% they would have lost in the S&P 500 or the 3% interest in a simple savings account.
This is very similar to the conclusions found by CXO Advisory Group in which the market timing accuracy of many well-known financial pundits were found to be less than what is required to outperform the market as a whole. Many of them did about as well or less than a fair coin.
Now this is just 1-year worth of data so by no means should it be seen as the end-all-be-all proof that active management is officially dead. But IT IS another rock of evidence that can be put on top of the mountain that already exists showing that most investors would be better off just buying, holding, and rebalancing a globally diversified portfolio of index funds.
Would you like some more coffee with your toast?
About the Authors
Tom Allen is an Accredited Investment Fiduciary (AIF®), Certified Cash Balance Consultant (CBC) and a Chartered Financial Analyst (CFA®) Level III Candidate. Tom received his Bachelor of Science in Management Science as well as his Bachelor of Art in Philosophy from the University of California, San Diego.
Mark Hebner - Founder, Index Fund Advisors, Inc.
Founder and President of Index Fund Advisors, Inc., and author of Index Funds: The 12-Step Recovery Program for Active Investors. He is a Wealth Advisor, with an MBA from the University of California at Irvine and a BS in Pharmacy from the University of New Mexico with a specialization in Nuclear Pharmacy.