The theory that passive funds outperform investment trusts is nonsense


Originally published at:

New research challenges the lazy assumption in some quarters that passive funds are best, but it’ll come as no surprise to investment trust investors. Passive outperforms active. This has become a widely accepted truth, supported by regulators, by many advisers and, increasingly, by private investors. It has become so widely accepted that it is barely…


When it comes to where I stand in the active v. passive debate then I’m part of the horses-for-courses faction.

The amount of research and data that exists is compelling in favour of the passive side. However (and, isn’t there always an however, nothing in finance is ever as black and white as it seems) this is how it looks when viewed from the standpoint of US investors and their own U$ dollar denominated domestic markets. The march of technology having brought efficiencies to the US market place that has made it increasingly difficult, for all but a few, to consistently beat Wall Street on a regular basis.

In my opinion, John Bogle, the founder of Vanguard, called it right for investors. In as much as while a majority of active money managers of US retail mutual funds may well be able to match, if not beat, an index fund overtime. When management and other ancillary charges are taken into account, a 1% to 1.5% annual reduction in performance as a consequence of such charges will always prove too big a handicap to that of say, 0.2% per annum of an index fund. Do the simple math and over a decade of compounding charges totalling 10% to 15% will always be a much bigger weight to carry than the 2% load of an index fund. This is why whenever US retail investors look at medium-to-long-term performance tables of domestically focused funds, index funds consistently feature in the second quartile and above the average. As John Bogle says, the vast majority of US mutual funds simply cannot compete in terms of the ongoing cost efficiencies of index funds – and, stay in business.

However (there’s that word again), the same does not necessarily hold true with non-US markets. For there has been research done, albeit not to extent and depth as that done on the US market, indicating that when performance tables of non-US funds are looked at then index funds tracking such markets are regularly ranked lower in third quartile of performers and, below the average (compared to second quartile for US funds).

So, the question is why should this be the case?

Well, by a process of elimination, if it can’t be blamed on a lack of technology which by its very nature and acceptance has become global. Then it must be because non-US markets are generally less efficient, less comprehensively analysed and consequently less understood when it comes to pricing their own domestic markets than the US. For if one accepts that a major function of financial markets is to discount all known information then Wall Street is apparently better at doing it than other stockmarket hubs outside the US.

I think the answer could well lie with the understanding of the word ‘opaque’ - meaning “not able to see through, not transparent.” For when it comes to financial matters and the litigious loving nature of the US legal system then opaqueness is a condition to be best avoided. A state of affairs in some other parts of the globe that is not always adhered to with such legal rigour as in the US. I tend to think of it as something of an historic leftover in the way that New and Old World orders have developed overtime. One founded on the values of New World egalitarianism verses one historically based on Old World feudalism and obedience to the Crown or State.

The upshot being that there appears to be greater scope for active fund managers to beat certain less efficient and less analysed ‘Old World’ markets than those focused on the more efficient ‘New World’ ways of doing things. This is when an investor needs to apply the horses-for-courses maxim – meaning “the practice of choosing the best person for a particular job, the best response for a situation, or the best means to achieve a specific end.” For it’s the responsibility of an investor looking to go down the active management route to pick the apparently right people to do the delegated job no matter what part of the globe or sector it is. There is really no other way of doing it than to get to know your fund managers, their strengths, weaknesses, regions and areas of expertise and experience. The information is all out there on the web somewhere, all that an investor is required to do is to put the time in pulling it together in order to make sense of it.

The good fund managers are like good football club managers. They don’t continue do what they do by chance. They’re hired to do the job because they have record of being good at what they do. If they continue to do the job well then they stay hired and get rewarded accordingly. They only move when they get a better job offer for the very reason that others think they are getting better at what they do. Both investors and fans alike can’t influence their judgement as to what stocks and players to buy and sell and at what price or to how such stocks and players will perform. While investors and fans will either agree or disagree with decisions made it is ultimately in the hands of others to decide their continuing tenure. Though, there’s always the nuclear option available for the disappointed investor and fan alike – that of voting with one’s feet.


Two sayings spring to mind: “Horses for courses” and “Lies, damn lies and statistics”.

A good manager will tend to outperform a passive fund in “inefficient” (poorly researched) markets but passives - with their usually lower costs - tend to do better in efficient markets like the US and UK, particularly in bull markets.

Like many, I prefer a mixture of ETFs and investment trusts, which depending on the sector and my requirements - it isn’t an all or nothing choice.

Finally even good managers can have bad spells and poor managers can do well for short periods through pure luck.


I won’t voice my opinion, however I would like to contribute some facts that must be considered. I understand this article analyses US listed ITs in the 2000-2009 period. Here is some recent & relevant data for the last 10 years:

20/05/2007 - 20/05/2017, relative to GBP with dividends reinvested. Data from FE

Nasdaq 100 (EQQQ) is up 353.62%
S&P 500 is up 137.09%
MSCI World is up 78.99%
FTSE 100 is up 12.5%

Investment Trusts
Frostrow Capital Worldwide Healthcare Trust is up 369.29%
Allianz Technology Trust is up 320.18%
Scottish Mortgage Trust is up 288.03%
Witan IT is up 99.6%
Seneca Global Income & Growth Trust is down 7.23%
Merchants Trust is down 9.99%

The pound is worth 33% less today than it was in 2007 and 72% less than it was in 1997. This needs to be taken into consideration when analyzing investment returns.