Our Passive Investment Strategy V Active Wealth Management Strategies?
July 7th, 2010 Company News, Investments, News, Observations, Retirement PlanningHow did Baxter Fensham’s Passive Investment Strategy Perform in 2009 in Comparison with Active Wealth Management Strategies?
2009 will go down in investment history as one of the years when the market fooled many of the active wealth management community. The year started as 2008 finished with the FTSE 100 index falling a further 14% and finally bottoming out in March. At this point many active managers, stockbrokers and private investors were wary of the possible future direction of the market and not wanting to compound their existing losses disinvested from equities altogether or at least were underweight in them going forward.
The next nine months produced one of the biggest bull market runs the market had seen for many years and as a result those who were not invested did not benefit. By adopting a passive strategy that ensured no disinvestment took place either on the way down or at the bottom of the market the Baxter Fensham portfolios should have benefited from this entire market rise between March and December.
So how did we do in comparison to our Actively Managed peers? Last week on 3rd July 2010 the Financial Times produced analysis from most of the Private Wealth Management groups showing the returns net of all charges that their balanced portfolios produced over this twelve month period. The lowest figure was 8.5% produced by Berry Asset Management while the highest was 25.7% produced by Kleinwort Benson. Of the 34 wealth managers that provided statistics the average return across the sample was 17.31% for the year 1st January to 31st December 2009. This means that if you had invested £100 on the 1st of January it would have been worth £117.31 at the close of business on the 31st of December, taking that you had achieved the average return of the actively managed wealth management groups in the sample.
However as we know statistics can be misleading and as with any sample some of these returns were significantly above the average while others were significantly below it. Therefore the problem arises as to how you go about choosing the wealth management group in the first place that will at least give you back this average return and hopefully a premium on top to reward you for the 47% chance (see below) of getting the decision wrong.
If we look at the sample of the 34 wealth managers who returned their results approximately half (18) of these actually managed to beat the average and 16 failed to match it (47%). Thus according to these statistics if you choose your wealth manager based on who you know, the chap down the golf club or simply a prestigious name you have a little under a 50% chance of underperforming the average. It is also worth noting that in the group who did not manage to beat the average are names such as Cazenove Capital Management, Close Brothers, J.P. Morgan Private Bank, Rothschild Private Banking and Trust and Towry Law. Thus the gravitas that goes with an established name in no way guarantees you success, Towry Law in fact returned the second lowest figure of the survey with 10.9%. However more frustratingly for those investors that did manage to pick the top performing manager in 2009 (Kleinwort Benson), there is no guarantee that they will reproduce a similar performance in 2010. In fact if you examine their 5 year returns in the same survey they are 6th from bottom in the same group of 28 of the 34 wealth managers who returned 5 year data.
To compare how Baxter Fensham fared against the active competition we used our balanced portfolio which holds 60% equities and 40% bonds which was a fair approximation of the balanced portfolios submitted by the other groups. If our investment philosophy works we should see a return of approximately the average produced by the rest of the market.
We can report that the return net of all fees and charges on the Baxter Fensham Balanced Portfolio between the same dates was 18.1%.
Thus by taking a passive approach and by using low cost investment funds we have managed to beat the average return produced by the major players in the Private Client active wealth management community. This was achieved while at the same time reducing risk to the client by ensuring that they did not catastrophically underperform the market by picking one of the poor performing managers and by reducing volatility through a disciplined philosophy that did not try to either market time or asset select.
None of this however is a great surprise. It is merely statistically more likely than unlikely to happen due to the fact that we use passive funds and buy the whole of the market for our clients. We are therefore statistically going to achieve market return with the possibility of greater than market returns due to a tilt towards small cap and value stocks in our portfolios. Our success is therefore not due in any way to clever trading strategies, hunches, gut feelings, in depth company analysis or luck, it is simply down to the markets and understanding how they work and where capital returns come from. Our approach therefore does not look to “chase the ace” by constantly trying to second guess which sector of the market will be the best performer next year or by trying to pick the fund manager that will be the on the top of the pile. Academic evidence suggests that the moment you try to do this two things happen, firstly you significantly drive up the trading costs of your portfolio thereby reducing the returns and secondly you introduce a huge degree of “man made risk” in to the portfolio through the possibility of simply getting the decisions/hunches/research wrong and thereby underperforming the market.
Through our financial planning structure we can identify the amount of wealth that you need to accrue to achieve your goals (your Smart or Magic Number) and from this we can then identify the return you need to achieve that number and hence the degree of risk you need to take. Remember risk and return are related so if you need to take risk to obtain your objectives get rewarded for it. Why take risk when there is no need or no potential pay off?
Sources
FT Money “Private Client Wealth Management Supplement” Saturday July 3rd 2010-07-06. Raw data obtained from FT Ledbury Research.
Baxter Fensham Balanced Portfolio Performance net of all fees data obtained from Transact performance analysis tools
