However, as Dido Sandler argues in this week’s cover story on page 20, it is difficult for active fund managers to beat the market in either set of circumstances. At least in developed markets the performance of the average actively managed fund is, as you would expect, average. So once fees are taken into account, it is no surprise that active funds tend to lag the index. Those that do outperform often do so by luck. Even if stockmarket returns were completely random, some funds would be top-quartile and others bottom-quartile. The worst type of funds are quasi-trackers. These more or less track an index, but charge investors active management fees for the privilege. Those investors who want to track an index are clearly better off buying a tracker.None of this means there is no room for actively managed funds. Such funds should be constructed to meet investor needs rather than slavishly following the market. Although such an objective may sound obvious, it is rarely achieved in practice. Fund managers feel under intense pressure to stay close to their respective stockmarket indices. But such indices are not constructed for the benefit of investors. The FTSE 100 consists of the 100 largest stocks on the London market, yet there is no reason why it makes sense as the basis of a portfolio for investors. Too many fund managers are more concerned about not underperforming their peers than serving their investors. The easiest way to avoid such underperformance is to follow the herd by
clustering around the index. The notion of “tracking error” adds weight to such behaviour. Strictly speaking, this is not an error but the deviation of a fund’s performance from its benchmark index. However, the fact that such a discrepancy is viewed as a mistake says something about the
attachment of fund managers to indices. Essentially, fund investors have two ways to go: invest in tracker funds that cheaply follow a stockmarket index, or opt for funds that are focused and genuinely actively managed.