When a fund manager beats the market, we tend to assume they’ve done something clever. But where does that outperformance actually come from? The answer might surprise you. A video on the Bloomsbury Wealth YouTube Channel.
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Transcript: Robin Powell & Craig Lazzara/ Founder of SPIVA
Robin Powell: When a fund manager beats the market, we tend to assume they’ve done something clever. But where does that outperformance actually come from? The answer might surprise you. Because active management isn’t like most industries. It’s a zero-sum game — one manager’s gain is always another manager’s loss. Craig Lazzara spent decades studying this at S&P Dow Jones Indices, where he ran SPIVA — a scorecard that measures active fund performance. And as he explains, once you understand the arithmetic, the whole picture changes.
Craig Lazzara: “If the job of a manager is to outperform the market, what is the source of their outperformance? Well, the source of their outperformance is the underperformance of the managers or investors who underperform the market, because at the end of the day, there is no net source of alpha. Add up the alpha for everyone in the industry, if you’ve properly defined it, the sum is zero.”
RP: So if the winners can only win what the losers lose, there’s a crucial follow-up question: how good is the competition? And the evidence is clear — it’s been getting tougher. In a Wall Street Journal interview towards the end of his life, the late Charlie Munger, Warren Buffett’s long-time partner, was asked how the investing world had changed since they started out in the 1960s.
CL: “They asked him, among other things, you and Charlie have been together since the late 1960s: how has the investing world changed in the time since you two started? And Munger’s immediate response was, oh, it’s much more difficult. When we were young, we had idiot competition. And the words “idiot competition” — that is a direct quotation, I’m not making that up. So if Munger thinks he had idiot competition in the sixties and seventies, and better competition now, that tells you a lot about what’s happening to skill levels in the active management community.”
RP: So the competition is fiercer than ever — and yet, most active managers still can’t beat the market. The SPIVA data show that in a typical year, roughly 60 to 65 per cent of active managers underperform. But that’s the short-term picture. What happens over longer periods?
CL: “As you extend the time horizon, the results get worse, not better. So although on average maybe 60 to 65 per cent of managers underperform on a one-year horizon, if you look at a 10-year or a 20-year horizon, the underperformance statistics go to something on the order of 85, 90, sometimes as high as 95 per cent. The fact that the long-term results are worse suggests to me, at least, that the short-term results are an accurate reflection of reality.’”
RP: At this point, many investors think: fine, most managers fail, but some don’t — I just need to find the right one. It’s an understandable instinct. But as Craig Lazzara points out, even the most famous names in investing haven’t been immune.
CL: “Most active managers underperform most of the time. Historical performance is not a reliable guide to future performance. Those are the rules. Are there exceptions? Yes, there are exceptions to the rule. The reason you know Peter Lynch’s name is that he was exceptional. If everyone could do it, he wouldn’t be a big deal. It’s the rarity of his achievement that makes him notable. And the same is true, most famously of all, of course, Warren Buffett. Everyone knows who Warren Buffett was. Very successful active manager. And yet, Berkshire Hathaway, for at least the last ten years, has underperformed the S&P 500.”
RP: If even Warren Buffett’s Berkshire Hathaway has underperformed the index over the last decade, it should give any investor pause. The arithmetic of active management isn’t a matter of opinion. It’s maths. The competition is getting fiercer. And the longer you look at the data, the harder it is to argue that picking the right manager is a reliable strategy. For most investors, a simpler approach — broad diversification, low costs and a long-term plan — will serve you far better.
Disclaimer — The information in this video does not constitute advice or a recommendation, and you should not make any investment decisions on the basis of it. If you do however require advice please do not hesitate to contact Bloomsbury Wealth.
