A Different Way to Drive Performance
In the light of recent domination of the financial headlines by the falling from Grace of Neil Woodford, a timely reminder of our investment philosophy and why we believe it to be the correct way to invest. Almost exactly four years ago, we ran the following article…
Given the amount of free publicity that Neil Woodford and his new CF Woodford Equity Income Fund have received over recent weeks, it would be easy to assume that the fund is an odds on cert to beat its peers. There hasn’t been this much hype about a new fund launch since Anthony Bolton of Fidelity Special Situations fame launching his China fund.
We are constantly reminded by fund groups and regulators that past performance is no guide to future performance yet the cult of the “star” fund manager tempts us into forgetting this. In fact, most fund advertising sells us past performance whilst, in the small print, telling us that this is no guide to future performance!
Therefore, whilst the fund will no doubt sell like hot cakes, there really is no guarantee that Mr Woodford’s record at Invesco will be repeated in his new venture. If making money really was that easy, we would all be able to name more than just one or two fund managers. The vast majority of fund managers fail to beat their benchmark over short periods of time let alone in the long term... but that doesn’t mean that they are stupid or bad investors. It’s just that once costs are taken into account, it is very difficult for any fund manager to beat their benchmark. Some will, of course, but just as it is hard for them to outperform, it is equally difficult for any of us to predict, in advance, which will do well and which won’t. Too much of the financial services industry relies on crystal ball gazing.
Just as research and logic suggest that picking a fund manager who will outperform in the future is pretty tough, research and logic also suggest that fund costs are one of the best predictors of fund performance. In the long run, and on average, the lower the fund costs, the better the performance.
There will, of course, be exceptions (with the benefit of hindsight) but successfully picking them in advance seems unlikely. Whilst we wish Mr Woodford the very best of success, we will ignore the hype and will leave it to others to buy the fund.
Four years later, and we still passionately have the same beliefs. We hate to say I told them so, but we will none the less; it’s too valuable a lesson not to. As our clients know, and future clients will learn, we believe in a passive investment strategy that delivers very low cost highly diversified portfolios. This involves buying a collection of stock market indices such as FTSE All Share, US Equity Index, Government Bond Index etc. for a very low cost and blending these assets together to match your attitude to investment risk. To help explain this, read on.
A Different Way to Drive Performance
Considering the historic long-term direction of markets in general, an index-tracking passive investment doesn’t try to “beat” the market, it simply tries to “be” the market.
Think about passive investing like driving in rush hour traffic. Some drivers actively jump from lane to lane trying to beat the traffic, only to discover that sometimes they’ve chosen a faster lane and other times a slower one. Other drivers simply go with the flow, passively sticking with one lane and spending less effort in the process and without the risk of coming off the road. Traffic is what it is. All lanes go the same direction. Continually changing lanes can be tricky and dangerous. And often, both drivers arrive at or around the same place at the same time.
The difference is what it cost to get there. Operating costs — gas, oil, maintenance, wear-and-tear — can add up when you own a car. Relative cost is also a consideration when investing. Research and trading carry expenses, so actively managed funds tend to cost more to run than passively managed ones that merely track an index. And costs reduce
returns. In short, a passive investment holds its lane.
The closure of Neil Woodford Investment Company and thousands of investors suffering huge losses, both in his funds and the funds he managed for St James Place has demonstrated the bad things that can happen when investment managers take risk with portfolio concentration and liquidity. The truth is that there is risk inherent in the concentrated
nature of many portfolios and to an extent with liquidity too. Most of the affected Woodford investors were driven towards these investments by large fund platforms advertising them or putting them on a ‘recommended’ list.
We believe that this demonstrates the value of proper financial planning to help avoid investors making inappropriate or misinformed decisions. Investors in several Hargreaves Lansdown funds have also been exposed to the Woodford Equity Income fund and there has been some comment that these funds could be suspended if investors continue their current rate of withdrawing their money.
Some commentators are now beginning to question whether, other concentrated active funds could survive a period of sustained withdrawals following a period of underperformance of the fund or market in general, particularly the larger funds.
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