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The market needs active managers - just far fewer of them

January 14, 2015
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Of course it’s possible for active fund managers to add value. But in practice, after costs, they very rarely do. Part of the problem, says Weston Wellington from Dimensional Fund Advisors, is there are far too many of them.


Hello again.

If you’re a regular viewer of Sensible Investing, you’ll know we don’t recommend using actively managed funds.

Some say we overstate our case, that we somehow have it in for active managers. In fact neither of those is true.

In a recent interview he gave us, Weston Wellington from Dimensional Fund Advisors explained how there’s no contradiction in having the utmost respect for active managers, while at the same time advising clients to avoid them.

Weston Wellington says: “It is very, very difficult to distinguish luck from skill. I’ll put another way, it’s very easy to persuade ourselves that we can identify great performing stocks or great performing money managers. If it were the case that it were so easy to identity terrific money managers we ought to be able to do it. But in study after study after study we just don’t find that evidence. I think we ought to emphasise when we are making these statements, this is not a suggestion that active money managers are someway incompetent or greedy or they are looking at the wrong things. If anything, it’s a vote of confidence, saying there were so many talented clever, hardworking money mangers out there, all flipping through the thousands pages of corporate reports and information, all that competition serves to drive prices quickly enough to their fair value that it eliminates the easy opportunities for anybody, smart or otherwise, to gain an advantage.”

We often hear that some markets are less efficient than others, that there are particular asset classes in which a fund manager’s expertise really can add value. So what does Weston Wellington make of that?

“I would never argue that there are no situations where clever active management might be able to add some value. I just haven't found an asset class yet. When I hear that argument that seems to apply. The ones we hear most often are small company stocks that are somehow less well researched and therefore they have greater opportunity for active managers, or emerging markets. Now right away you run into two big problems. Number one, you still have a market place that consists of all the small cap securities or all the emerging market securities and you have the universe of investors holding theses securities. You still have the zero sum game problem. And from an empirical standpoint, when we go looking for evidence among actively managed emerging market or actively managed small company strategies we find no evidence what so ever that these managers have any greater ability in this market place. If anything, the data shows that they’re performing even worse.”

Ultimately, of course, we need active fund managers to set prices. But that certainly doesn’t mean that every investor needs to use them.

Weston Wellington says: “To the extent active money managers study companies, access whether projects are useful or not useful, reflect those assessments in security prices, they’re performing a social benefit. The real question is, how many active managers do we need to keep markets efficient to keep prices fair? All the evidence we have from these academic studies of manager performance suggests we have way more mangers than we need to keep the markets efficient.”

That’s about all for now.

Just time to remind investment professionals who share our evidence-based investing philosophy that we’re about to start producing regular educational content for advisers.

If you’d like to subscribe, please contact Richard Wood. His email address is [email protected]. That’s [email protected].

Until next time, thanks for watching and goodbye.

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