GOLFERS are familiar with the concept of a “mulligan”—the chance to retake a shot. Give an averagely talented player enough mulligans and he or she will get one close to the hole. And a version of the mulligan exists in fund management too.
Readers will be familiar from past blog posts with the idea that actively managed funds cannot be relied upon to beat the index. Many of these studies are conducted in the US market, which is probably the most efficient (and thus hardest to beat) in the world. But the same is true in Europe.
Figures from S&P Dow Jones Indices show that, over the ten years to December 2017, less than 15% of euro-denominated European equity funds beat their benchmark; for emerging market funds, it was less than 3%; and global funds, under 2%. For sterling-denominated funds, less than a quarter of both European and UK equity funds beat the index.
But I took a closer look at the UK market, because of an intriguing detail. The annualised return of UK equity funds was 7.27%; the index return (S&P’s broad market index) was 6.48%. So how come the average fund beat the market when, the figures also show, most funds did not beat the market?
This is where the mulligan rule comes in. The ten-year performance returns are for funds that have survived ten years. But most funds did not manage that; only 43% of UK equity funds that were being operated at the start of 2008 were still going at the end of 2017. The ones that closed were, inevitably, ones that underperformed. If a fund survives for ten years, the chances are that it had a pretty good record. That is why managers can advertise funds with strong performance; if they have a bad fund, they can just close it and start again.
Ah, some investment advisers might say (indeed, one did tweet this to me) all passive managers will underperform. But I looked at the Legal and General UK index tracker, which is one of the largest, if not the cheapest. Its compound ten-year return was 6.4% (it tracks the All-Share not S&P’s index). It will never be the best performer in the sector but clients can be sure it won’t be the worst either.