We don’t need to dwell on Buxton’s track record (annualised return on his UK Alpha Plus fund of 13.7 percent over 10 years), but combined with Mark Lyttleton’s departure from BlackRock – his own star rather faded of late – I am drawn to ponder the funds industry’s views of, and hunger for, stellar talent.

It is attractive, and reassuring even, to believe that the people running our money are blessed with some innate skill for playing the markets, but I recently had to re-consider my own views on natural talent when talking to Matthew Syed, now a journalist and author, but previously England’s number 1 table tennis player for a decade. A competitor at two Olympic Games and winner of three Commonwealth Gold medals, Syed has some experience of being praised for his apparent natural ability.

He contends that some of our most cherished notions about natural talent are misplaced. Instead he argues persuasively that practice, opportunity and belief are far more important than genetics in determining success.
In a nutshell, Syed asserts that “when you look at the science rather than our own implicit biases, you arrive at the conclusion that champions are not born, they are made.”

Rather than going through these arguments in full, which Syed does best himself in his book ‘Bounce’, I will focus on a few aspects that have direct relevance for the funds industry and the cult of the star manager.

FEEDBACK

Exposure to the right opportunities is obviously vital for an Olympic athlete or a top fund manager to succeed, but Syed’s most consistent theme is a simple one: practice.

Not hard work for building character, or for some other honourable good, but because purposeful practice is far more influential in determining an individual’s success than a reliance on genes. “Those who believe in talent tend to lose motivation. Why work hard if it is all about having the right genes?”

Commodities guru Jim Rogers’ recent comments on his own experience are interesting here. “To the extent that I had any success, it was from homework,” he said. “I was willing and able to work harder than other people, but I was also willing and able to think differently from other people.”

Of course Syed’s emphasis on practice over talent does not mean that he believes effort alone guarantees success. The right mentor – perhaps the right investment manager – to learn from is vital. Intertwined with hard work is the often discomforting task of learning from feedback.

This has the potential to be a huge issue for star managers if the culture in their company is not conducive to giving (or receiving) constructive feedback, or to “think differently from other people,” in Rogers’ words. Not having your ideas challenged by colleagues, or believing your own billboard ads, is surely a slippery slope for a star fund manager.

As Syed puts it, “For those who are already ahead of the pack, it is vital they are pushed. If they stay within their comfort zone, they will not learn.”

The perils of lacking feedback, of not continuing to learn, can be seen in a striking example that Syed offers of research by Jeffrey Butterworth in 1960. This examined the ability of doctors to make diagnoses using heart sounds and murmurs over time. He found that while accuracy increases with experience as a person progresses from student to certified cardiologist, he also found that accuracy actually diminishes over time for doctors in general practice.

The explanation for this apparently surprising finding? GPs encounter cardiac cases relatively infrequently, and they have relatively limited feedback on which to base their judgments and diagnoses. How to improve? Well, after short, targeted practice, “their diagnostic accuracy soared,” says Syed.

This suggests a parallel with fund managers diagnosing, and dealing with, financial crises – even rarer than heart complaints, but also with devastating consequences. In turn it would be interesting to delve into the planning fund managers undertake for dealing with future crises of different shapes and sizes.

There is some evidence that fund managers have already learned to use their experience effectively. Analysing mutual funds registered for sale in the UK in preparation for this year’s Lipper Fund Awards, we compared winning funds against their peers and found that the average tenure of the winning fund managers is longer than the rest. From this initial examination the evidence was pretty consistent, suggesting that the fund management community may actually be a good example of practice in action – and of seeing experience make its mark.

BELIEF

Building success over the long term brings us to another aspect to consider, and something someone like Jim Rogers has in abundance: belief. Any individual has to be motivated enough by their profession to persevere with the hard work needed to succeed.

There are many extraordinary examples of the scale of hard work undertaken from an early age. Mozart had clocked up 3,500 hours of music practice before his sixth birthday, according to Michael Howe (‘Genius Explained’, 1999), while Geoff Colvin (‘Talent is Overrated’, 2008) estimates that Japanese ice skater Shizuka Arakawa fell over 20,000 times while practising her skating (starting at the age of five), but ultimately won an Olympic gold medal in 2006.

As Syed puts it, “When you appreciate that it has taken many thousands of baby steps by world-class performers to get to the top, their skills do not seem quite so mystical after all.”

This highlights the need for perseverance, underpinned by a real belief in what one is practising and trying to achieve. As the statistics above illustrate, the sheer volume of work involved in reaching the highest levels of performance is difficult for outsiders to comprehend.

But this also hints at a classic conundrum for the fund management industry. Mutual funds are designed as long-term investments, but investors often buy and sell them far quicker if they do not think returns have been good enough over shorter periods. “Baby steps” can be too small or too slow for many investors.

To a certain extent this simply underlines some of the pressures that asset managers have to deal with. But taking this aspect together with the others from Syed, one finds a well-rounded case for fund businesses to build structures which give opportunities to those willing to work hard, provide constructive feedback throughout the organisation, and create a company culture that really motivates people.

Before ending, the number cruncher in me cannot help but ask Syed about those who practised hard but failed. Is there a survivorship bias in the statistical evidence?

“I am glad to say that I found no evidence of this,” he says. “With deliberate and purposeful practice, we are all transformed with dramatic implications.”

Encouragement then even for those less-than-starry fund managers currently languishing at the bottom of the league tables.

((This is the third in an occasional series of interviews offering alternative insights for the fund management industry, which have also looked at betting on horses and charitable donations. ))

So far the impact of the financial crisis has not hit the wealthy as hard as many protesters would like. Even French millionaires have a found an escape from the modern-day guillotine that is a 75 percent tax rate, in the shape of Russian president Vladimir Putin.

But what about the level of charges that high net worth individuals have to pay for investing in hedge funds? Even though there has been some downward pressure on the annual management fees charged, the most common model remains “2 and 20” — 2 percent of the fund’s assets and 20 percent of its performance every year.

In real terms, for a 50 million pound hedge fund that returned 8 percent this could mean an annual fee of 1.8 million pound. The equivalent mutual fund in the UK would typically charge less than half this amount. Perhaps this should be a reason to consider switching to a different fund manager. But European investors have traditionally been more persuaded by the argument that you have to “pay more to get more” than by the notion that a fund manager should minimize costs in order to maximise returns. (Having said this, institutional investors are clearly more savvy when it comes to fees; it helps that they have the clout, through the volume of investable assets, to negotiate).

Yet perhaps the winds of change are blowing. Cantab Capital Partners has launched its Core Macro Fund with a “1/2 and 10” fee structure. The management fee of 0.5 percent (which does not cover back office costs – hedge funds do not typically quote total expense ratios) applies to those investing at least $50 million. Those investing less money will pay more, but still enjoy the 10 percent performance fee. It is hard to argue with Cantab Capital Partners’s assertion that this is “exceptionally low cost” for institutional investors, not least when considering that the fund has daily liquidity and there are neither redemption penalties nor gating clauses. But for performance fee savvy investors, the fact that there is no hurdle rate cannot be ignored. And for those looking for signs of a revolution, Cantab’s other funds have not changed their fees to move in line with the new fund.

There are others that have grappled with the issue of fairness in performance fees, either through the way the fund itself is structured, as with Optcapital, or Aquamarine Capital’s variation on the level of the performance fee. The Aquamarine Fund charges either “1 and 20” or “0 and 25” depending on the share class, with the performance fees subject to 4 percent and 6 percent hurdle rates respectively.

Products with a “no win, no fee” structure are not unique to the hedge fund arena, with mutual funds from the likes of Vinculum entering the fray last year and Bedlam manning the barricades ten years earlier. The Bullhound technology fund also tried this back in 2000 and subsequently closed. Of course mutual funds are also open to the ‘hoi polloi’ who, as we all know, are already revolting, not least in Greece.

PERFORMANCE FEES

There are some signs that millionaires are taking steps to move away from hedge funds. Reuters recently reported that Deutsche Bank’s Alternative Investment Survey showed that family offices and high net worth investors now account for just 4 percent of industry assets, down from 18 percent in 2002.
Having said this, this looks to be a move in search of higher returns, rather than away from higher fees.

In the UK, the blow being struck against high performance fees has come from a more surprising quarter. Here Independent Financial Advisers (IFAs) are those with both the clout and, it seems, the inclination to discourage use of such fees among mutual funds. Their use is most common among funds seeking absolute returns in all market conditions. Many of their strategies mimic traditional hedge fund strategies, and many of them have mimicked hedge fund fees too.

IFAs, most notably Hargreaves Lansdown, have been publicly sceptical of performance fee structures and it looks as though asset managers in the UK have responded. Since the fee structure was first allowed for open-ended funds in 2004, the number of funds being launched with the fee rose to a peak in 2006, but has since declined to the point where only two funds with this structure were launched last year.

Lest we lose sight of the millionaires, it is worth casting an eye to Switzerland, where the Swiss Federal Supreme Court has apparently taken up the mantle of the 1789 Assemblée Nationale and stated that retrocessions, or trail commission, received by banks for asset management services belong to the client.

Although the full implications of this move are still being considered, Ernst & Young have helpfully carried out a survey where respondents generally believe that the Court’s move will improve transparency in the industry, but still the price of bank services (including private banks) are not expected to fall.  The experience in Switzerland so far sounds a lot like that in the UK with the Retail Distribution Review (RDR), which was originally aimed squarely at the man in the street. Perhaps millionaires and the downtrodden retail investor do indeed have common cause.

Sheila Nicoll, Director of Conduct Policy at Britain’s Financial Services Authority (FSA), had perhaps been reading Kenneth Grahame before her recent speech, and her words are likely to have sent a chilly wind through the willows of the UK funds industry.

The warning “poop poop” being sounded by the regulator has been getting louder and louder. Indeed the FSA may even be traveling faster than Labour Party leader Ed Miliband, who has recently suggested that he would impose a 1 percent cap on pension charges.

It was not so long ago that the FSA took a very different approach and removed its rules on excessive charges on the basis that “there may be no appropriate benchmarks” to determine this. They went so far as to say that “we do not act as a price regulator, and we do not consider it appropriate for us to take such a role.”

At the time, this move seemed all the more surprising as it was this very regulation that the FSA had referred to when trying to allay the Financial Services Consumer Panel’s fear that in allowing performance fees for open-ended funds, there was no requirement to cap such fees.

The more recent change in the FSA’s thinking was shown in its paper on product intervention, stating its intention to scrutinise both performance fees and the high charges for some index-tracking funds. The FSA did not shrink from suggesting that “it is possible to envisage the role of the regulator in imposing limits on price or excessive charges to remedy competition problems.”

FIDUCIARY DUTY 

The loudest voice in the woodland is surely that of Martin Wheatley, the future head of the FSA’s successor, the FCA, who has questioned how an investor can tell whether charges are fair. He has promoted the idea of fund managers “adopting a fiduciary duty to their investors, something that would offer an extra level of commitment beyond simply the letter of our rules.”

While the Investment Management Association (IMA) is looking again at this issue, the funds association initially responded to Wheatley’s speech by questioning the “legal underpinning” of the term fiduciary duty. Having said this, the IMA has not stuck its head in the sand, publicly recognising such obligations earlier this year.

It also detailed the governance arrangements of funds back in 2005 in a paper which gave a succinct definition of ‘fiduciary duty’: “Both the Manager and the Depositary have an obligation to act at all times in the best interests of Investors, disregarding their own interests where they conflict with those of the investor.”

But the IMA made it clear that this duty stopped short of the depositary taking a view on “commercial matters” such as the level of the manager’s fee.

The Wild Wood that is the US funds industry casts a shadow over the discussion. First, the US regulator models itself as “The Investor’s Advocate” – an approach more akin to the new FCA – and second, it holds that fiduciary duty does relate to the oversight of funds’ fees.

Here, section 15c of the 1940 Investment Company Act comes to light, whereby fund boards (a majority of which are independent) must monitor their funds’ fee and expense levels in relation to the rest of the industry. This need not create a decisive argument that fund boards are a panacea, but it does demonstrate a different and viable approach to overseeing fees.

One way this scrutiny manifests itself is in passing on economies of scale achieved to investors, as discussed in a previous column. If the UK and European industries are to demonstrate that they are giving investors as fair a deal as possible, then this nettle needs to be grasped. Simply capping fee levels at a fixed percentage will not suffice.

WEASELS OR BADGERS?

If funds can justify the fees they charge by their performance – as many do – then some of the critical voices may be quieter, or find a less receptive audience. But demonstrating this over both the long term (as mutual funds are designed to do) and the shorter term (say up to 3 years, which has a more significant impact on fund sales) remains the challenge for asset managers.

Some consumers may well see fund managers as weasels, rather than an array of friendly moles, wise badgers or shrewd water rats. But such a perception crucially highlights the problem of exactly how consumers think of fund fees: some see them simply as the fuel for a lifestyle of fast cars and mansions out of step with the rest of society, while others will look at fees from an investor’s viewpoint, as a downward ‘drag’ on returns.

This second element, the actual cumulative impact of annual charges on average equity fund returns over ten years, is illustrated in the following chart:

Despite this, retail investors have traditionally given more weight to funds’ past performance then their ability to keep costs low. This leads on to a question that the FSA’s Wheatley posed: “we might ask ourselves whether it is a problem that the industry appears to compete predominantly on the aspirational aspect of its service… when it is the one thing that cannot be compared and measured by potential investors.”

The counter-argument to this question must be that as long as investors, or their advisers, place a greater emphasis on a manager’s track record than on charges, then it remains a very tough proposition to grow a retail business based on what investor behaviour should be (depending on your perspective), rather than one based on what it is. Perhaps this is the equivalent of traveling quietly in a horse-drawn caravan while others race by in motor cars.

The impact of such attitudes is that the average annual charges at mutual funds in the UK have slowly been rising. Part of the reason for this may be laid at the feet of independent financial advisers (IFAs) and platforms, in the form of trail commission, and it is this that will be radically changed with the Retail Distribution Review (RDR) next year as customers will have to agree separately the fees they pay for advice.

A chart showing the historical trend in annual fund charges can be seen below:

So are managers really emerging from their burrows? Surely all fund companies have been buffeted by the financial crisis and witnessed the march towards greater regulation, not only the RDR in the UK, but also laws from across the Channel and the Atlantic.

As for investors, there is greater cost disclosure underway, although this need not mean they will pay less overall. Regulatory changes have already resulted in there being far more choice for cost-sensitive investors, who can certainly pay much lower fees unless they believe a manager is really worth it. Or as Kenneth Grahame put it, “good, bad, and indifferent – I name no names – it takes all sorts to make a world.”
(Editing by Joel Dimmock) (joel.dimmock@thomsonreuters.com; Twitter: @reutersJoelD; +44 20 7542 3505)

One of the reasons for the rise of absolute return funds – those seeking to deliver positive returns in all market conditions – is that the industry has been trying to deal directly with client expectations left shattered by the financial crisis.

On top of their investment objectives, one way that absolute return funds say they have tried to better align investor and fund manager interests is by the use of performance-related fees, paid as a proportion of a fund’s returns, not a fixed percentage of assets (although pretty much all funds will charge the latter fee too). But do performance fees actually help to deliver more consistently positive returns, and do they do this for lower levels of risk? Or, much like making ill-advised promises about tuition fees, do performance fees actually make it more likely that a fund manager will have to say sorry down the line?

In the IMA’s Absolute Return sector (established in April 2008), 63.5 percent of funds have a performance fee structure in place. That contrasts with about 3 percent for all UK-domiciled funds.

Because funds in this sector are managed with the aim of delivering above zero returns on a rolling 12 month basis, it is this that has been used to compare their performance. Each fund’s performance was calculated at monthly intervals, looking at a 12-month period for each interval (up to the end of July 2012.

As a result, the data does not reflect a simple snapshot of how absolute return funds have performed over any one period, but instead gives a more detailed view of their ongoing performance since the inception of the sector (or since a fund’s launch, if later).

Using this measure, we can show that funds with performance fees delivered positive returns 62.1 percent of the time, while their peers with a more traditional fee structure managed it 63.5 percent of the time.

A summary of the funds’ absolute return performance is shown below:

RETURNS AND RISK

In the chart, funds are put into three groups: those achieving positive 12-month rolling returns less than 50 percent of the time, those achieving this between 50 percent and 74 percent of the time, and those funds achieving this goal at least 75 percent of the time. The funds are also split between those with and without performance fees.

This shows that funds with performance fees are relatively evenly split between the three performance ‘bands’, while there are more significant differences for those with a traditional fee structure. While the latter have fewer ‘poor’ funds (21 percent versus 31 percent among funds with performance fees) and more ‘average’ funds (46 percent versus 33 percent), the ‘good’ funds make up a fairly similar proportion of both totals (33 percent compared to 36 percent).

A different approach has to be taken when looking at risk. Here two universes of absolute return funds were assessed: funds with at least 3 years history (37 funds, of which 20 have a performance fee), as well as a larger universe of funds with just 1 year history (69 funds, of which 45 have a performance fee).

Both volatility of returns, expressed as standard deviation, and maximum drawdown were calculated. To gain a further level of granularity in this comparison, both the mean and the median was calculated to present average historical risk measures for these funds.

The findings seem to be fairly clear: in seven of the eight comparisons made, funds with performance fees look to have been more ‘risky’, on average, than those funds without performance fees.

But further exploration of historical risk is warranted.

Both standard deviation and maximum drawdown were plotted for each fund over three years, distinguishing between funds with and without performance fees, in the following chart.

This neatly illustrates that 8 funds with performance fees are out of line from the other 29 funds (of which 12 have a performance fee) in their historical ‘riskiness’ (as measured by maximum drawdown and standard deviation).

Quite simply, those funds with historical characteristics that suggest greater risk all have performance fees. This also seems to support the point that a variety of strategies – with different risk profiles – are employed by funds seeking absolute returns.

Absolute return investors in the UK are not being forced to invest in funds with performance fees, both because a sizeable proportion (36.5 percent) of these funds maintain a more conventional fee structure, and because funds with performance fees have not demonstrated, on average, that they deliver better returns or lower risk.

Hugh Hendry, founding partner of Eclectica Asset Management, has gone so far as saying that “It is outrageous that managers with no long/short experience have the audacity to charge a performance fee.”

Clegg’s contrition was for making a pledge in the first place, not for breaking it. And with the sustained scepticism of financial advisers in mind, it’s no surprise that the number of UK fund launches with performance fees attached has declined.

It’s certainly difficult to make out a clear case for the better client/manager alignment that performance fees were designed to bring for absolute return funds. Some will plough on; some might make a good fist of it. But what odds on the poor performers plucking up the courage to apologise?

(Editing by Joel Dimmock) ((joel.dimmock@thomsonreuters.com; Twitter: @reutersJoelD; +44 20 7542 3505))

Caroline Fiennes is not one to pull her punches when talking about charitable giving, but the more I talk to her, or read her new book – ‘It Ain’t What You Give It’s The Way That You Give It’ – the more it becomes apparent that her philosophy is not all that different from that of a professional fund manager.

No self-respecting fund manager would invest in a company just because they were asked to. A fund manager will choose to invest (or disinvest) because they believe it will help their fund perform well and that the investment fits within their investment objectives. Fiennes, who advises companies and individuals on their giving, advocates a similar approach for any donor: be clear about your objective and find organisations that have done a good job of achieving this, not just the ones that market themselves well.

This is just the start. As James Caan, entrepreneur and philanthropist, puts it, “Finding, investing and supporting good businesses is hard, but identifying, donating and supporting great charities poses the same challenges.” This is all the more apt as Caan has also been the chairman of a fund manager, Insynergy Investment Management.

This is not to say that giving and fund management are natural bedfellows. A collaborative exercise between several fund groups created the Invest & Give fund, but sadly it did not generate significant investment and was eventually closed. Lipper data reveals that socially responsible investment (SRI) equity mutual funds in Europe have healthy assets of just over 50 billion euros, but this still accounts for less than 3 percent of the equity fund universe (1.8 trillion euros).

Yet investing and giving can learn from each other, despite their differences. Those fund managers who avoid hugging an index are clearly pro-active in their selection of investments. By contrast, charitable donations are typically made reactively.

At a simple level, most people are more likely to give to those charities that shake a tin on the high street rather than tracking down a cause they really care about. While relevant for anyone, for those giving more sizeable sums it is all the more important to make a pro-active decision.

“Start with your heart and then engage your mind,” as Rebecca Eastmond, Head of Philanthropic Services at JPMorgan Private Bank puts it. This emotional dimension is crucial: which cause really matters to you and what sort of impact are you hoping to have?

DONKEY DONATIONS

Fiennes urges potential donors not to follow the herd – a classic dictum for many fund managers. For example, she cites data which show the Donkey Sanctuary spending over 2,000 pounds a year per donkey, while mental health charities in the UK only get 714 pounds for each of their beneficiaries. Is this really where our priorities lie?

Having decided where you want your money to go, you should then decide how you want to give, or in other words, the type of change you hope to make. Fiennes illustrates the dilemma by citing the work of New Philanthropy Capital, which attempts to give potential donors a better understanding of the difficult relationship between identifiable, and satisfying, outcomes for individuals (or donkeys) and the more nebulous pursuit of a wider, and potentially more useful, impact on society. The fact is, one tends to diminish the likelihood of the other.

Listening to this being explained, I could not help but hear echoes of different fund managers’ relative emphasis on ‘top down’ versus ‘bottom up’ investment (i.e. macro vs stock-picking) and the consequences of getting these calls right – or wrong. It is also apparent that ‘bad’ giving can be equally wasteful.

Such echoes could also be heard when discussing investment objectives. Fiennes’ advice is to give with no strings attached, echoing the unconstrained approach which has come increasingly to the fore in the investment industry, moving beyond hedge funds to the likes of PIMCO, for example. See here, and here.

She also warns against making too many demands of charities, with comments that will chime with fund companies sometimes weighed down by a constant cycle of completing requests for proposals (RFPs).

Having to complete a bespoke assessment of their activity for each major donor can be a massive burden for charities. As Fiennes says: “For sure, a charity should report on its overall effectiveness, but don’t make it write a long report just for you.”

COST COMPARISON

Parallels are not always appropriate. The relative importance of costs remains hotly debated in the funds industry, where they are inevitably a drag on returns to investors. But for charities the evidence seems to be pretty clear that administration costs are no indicator of whether a charity is any good. GiveWell, an independent charity evaluator, has gone so far as to describe costs (specifically the overhead ratio) as “the worst way to pick a charity”.

Picking a charity is no easy task. If you thought it was difficult to decide which mutual fund to invest in (there are about 2,500 domiciled in the UK and 35,000 across Europe), spare a thought for the charities vying for your attention – there are more than 160,000 of them, according to the Charity Commission. The relative pressures on small charities compared to small funds in the UK can be seen in the following charts.

Fiennes makes me squirm in my chair for suggesting that mydonations aren’t big enough to make much of a difference, pointing out that over half of personal giving in the UK is by people giving less than 100 pounds a month. She argues against diversification, suggesting that I give more to fewer charities (akin to those ‘high conviction’ portfolio managers that hold a concentrated portfolio of stocks), clubbing together with others (very apt for ‘mutual’ fund comparisons), or giving something other than hard cash.

On this last aspect, such views have recently been given shape with Miller Philanthropy’s launch of the Goodwill Exchange, a not-for-profit forum where professionals can register their area of expertise to provide small charities support on a project basis. Founder Gina Miller urges people to “give smarter, not just give more” with the specific aim of helping the smallest charities struggling to attract the money they need to undertake their work. In turn, spending more time on raising money can only undermine their efforts to concentrate on their charitable works.

Of course big donors can make a big difference – particularly if they give smarter. Fiennes cites the example of the Shell Foundation, which initially provided short-term, project-based support to many charities. Its grants failed 80 percent of the time. It then shifted its way of giving to finding a few charities, each of which was given a substantial investment (around 10 million pounds) over a longer period of time (normally five to seven years). The Foundation’s track record was transformed to succeeding 80 percent of the time.

Such an example shows that numbers can speak louder than words. Although what makes the numbers say what they do in this case was Shell’s change in approach, away from a quick tick in the charity box, to making their charitable giving a long-term investment. Or as Fiennes concludes, “to get your giving to achieve all it can, approach it as strategically and intelligently as you approach investing.”

(Editing by Joel Dimmock) ((joel.dimmock@thomsonreuters.com; Twitter: @reutersJoelD; +44 20 7542 3505))

Active fund managers’ ability to out-perform their benchmarks sits near the heart of any discussion on the relative merits of active versus passive. In broad terms the argument against investing in an actively-managed fund is that one takes on the additional risk that the fund will significantly under-perform the index, a risk that is exacerbated over time by the additional costs associated with such a fund.

The argument against passive is that one not only misses out on the possibility of superior, but also that, in principle, one is guaranteed to under-perform the index.

Clearly the case for active fund management goes hand-in-hand with the case for prudent fund selection. Indeed an industry has grown up trying to deliver the latter for investors, with professional fund selectors choosing funds to invest in and packaging this up as a product of itself: funds of funds. Assets invested in funds of funds in Europe stand at around 360 billion euros – noticeably greater than the assets invested in passively managed funds.

The most straightforward means to assess actively managed funds’ success in beating their benchmarks is to look at their latest performance figures. To this end all actively managed equity funds’ performance relative to their benchmarks was assessed over 1, 3 and 10 years to the end of December 2011.

The proportion of funds that out-performed varied from 26.7 percent in 2011, 40.0 percent over 3 years and 34.9 percent over the past 10 years. Solely for managers of UK equity funds, the figures were 22.4 percent, 42.4 percent and 37.6 percent.     But the issue of survivorship bias also needs be grasped. To do this, funds’ rolling returns were assessed every year from 1992 to the end of 2011. For 1-year periods, the proportion of equity funds that out-performed has varied between 59.1 percent and 26.7 percent, coincidentally the first and last years in this analysis.

TOUGH MARKETS

The annual average proportion of out-performing funds is 42.8 percent, at the higher end of the spectrum found in the initial analysis above. This suggests that the difficult recent market conditions have indeed had a negative impact on the proportion of active managers that have been able to beat their benchmarks.

The wide variation in out-performance depending on classification of funds is highlighted in 1-year rolling returns. For example, funds investing in Asia Pacific (ex-Japan) ranged from 8.3 percent (in 2004) to 83.8 percent (in 1999) of funds out-performing their benchmarks, while for UK equities the range has been much narrower, between 23.1 percent (2011) and 64.5 percent (2000).

For long-term investors the fact that an active manager does not out-perform in every calendar year is likely to be less significant than whether he/she can out-perform over a longer time period. To examine this, the data was expanded to look at rolling 3-year and 10-year periods.

For 3-year rolling periods the proportion outperforming is 41.4 percent and for 10-year rolling periods it is 39.7 percent. In other words, the proportion of funds out-performing over longer periods may have dropped very slightly, but it remains largely stable.

Over 3-year periods, a greater proportion of UK equity managers generally outperform than for other classifications. While the average proportion of Asia Pacific funds out-performing is slightly higher than that for the UK (48.9 percent compared to 47.6 percent), this is clearly the result of results posted over the first 10 years, while the more recent period has seen a significant fall for Asian fund managers.

For 10-year rolling periods among the largest classifications, UK equity managers impressively maintain their average proportion of out-performers (47.4 percent), while North American equities – already relatively poor cousins – worsen dramatically over this longer period, with an average of just 20.8 percent of funds out-performing their benchmarks.

These findings will clearly not settle the active versus passive debate one way or the other, but they do provide robust statistical research into funds’ relative performance. Such insights can better inform this ongoing discussion.