Value Investing – Passive Versus Active

November 19th 2015, Robert Wilcocks


Posted by Robert Wilcocks

I have just looked at the returns of a niche investment company after a new client asked me to look into the investment process, philosophy and returns. The firm in question have been in operation for 17 years and have a 'better-than-most' so to speak investment record for an actively managed fund. The niche is 'value investing' - which means buying good companies, based on their own research when they are priced cheaply by the stock market. The idea is that you get an upfront discount, and the company is successful over the long term (say 5 years, but could be much longer).

The return stated on their website was 10.2% a year, annualised after fees from 1998 - 2015. They shall remain nameless despite this being good! At first glance, who doesn't want 10.2% net return a year? I think all of our clients would take that if we could be sure this would continue. I would personally, of course, as well.

Then I looked at a targeted global value index - which charts the aggregate returns of companies globally from 1998 - end of 2014. The return of the index? 11.2%.

That's 1% more. From 1982 to the end of 2014, the index has produced 14.7% annually.

To give that some context, 1% annual return on a portfolio of £1million over 20 years is £184,000 - that's a house in Greece!

A 4.5% return (extra or not) a year over 33 years (I appreciate the time periods are different, but the fund only started in 1998 whereas the index returns have been on record since 1982) on a portfolio of £1m is £3.274 million. That's a nice flat in London!

I am being facetious, but the numbers ARE significant. Not to mention all the unknowns we can't ignore as advisers

This is yet another example of how buying an index fund (which at the same time massively increases diversification and therefore inherently reduces risk within your portfolio) is more often than not a more reliable, safer, and successful solution than buying an active fund.

We look at evidence and try to minimise risk. This fund has done well. No doubt the manager and his staff are highly skilled and educated - but can this good performance continue? What if the current investment manager of the fund leaves? Or dies? Do you sell, buy more, or follow the fund manager (but what if he retires?).

What if other investors lose faith and pile out of the fund, e.g. as with Pimco and Bill Gross this year (in Q1 2015, investors withdrew £68 billion from PIMCO funds when its founder left - its bond fund has been the world's biggest bond fund for two decades).

It has been historically proven that buying 'the market' so to speak via cheap index funds, keeping your total costs low via minimising trading, embracing diversification to reduce risk, and not trying to speculate, works over the long term. This has proven true for value stocks in this example, small caps stocks, and main markets like the FTSE 100 and S&P 500.

Happy investing.


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