Last week we wrote about the hidden dangers of portfolio self-management. Today, we would like to cover the same topic from the opposite angle. Many investors cannot understand why actively managed trading strategies in the stock market lose to indexes over the long term.
Back in 1968, the famous American economist Michael Jensen published his work “THE PERFORMANCE OF MUTUAL FUNDS IN THE PERIOD 1945–1964“. This book was the first to come to the stunning conclusion that none of the fund managers could beat the index over a long period. This research all but initiated passive investing, with the first index funds and ETFs.
COMMERCIAL REASON FOR PASSIVE INVESTMENT
A long-only manager takes a commission of 2/20 i.e., 2% of assets, 20% of profits (this is called the expense ratio – ER). Let’s imagine that the market has grown, say, by 10%, in this case you pay 2% plus another 2%, so 4% in total. If the market fell, you still have to pay the manager 2%. The manager has done almost nothing to affect the outcome of the investment, but they still get paid either way. In fact, the bigger a fund gets, the less incentive a manager has to drive returns.
In an index fund or ETF, the management fee is 0.1% – 0.2% per year. This is 10-20 times cheaper than manual control. And the returns are often better than active managers, as explained below.
STATISTICAL REASON FOR PASSIVE INVESTMENT
Let’s imagine the following picture: a few fishermen are sitting on the shore. Suppose one of them constantly holds their rod in the water, the second takes it out every minute to check the catch, and the third sometimes pulls the rod out of the water for two or three hours. Which one will have caught the most fish after a few months? The one with the rod always in the water.
The process in the stock market takes place in the same way. The explanation for this is that the probability of making a profit over a long period is proportional to the time spent in the market.
Take the limiting case: if you do not invest at all your profit will be 0.
Managers who regularly buy or sell, withdraw assets or hedge are not benefiting from the general positive trend of the assets that they own.
Investment portfolio management with arty:
arty’s portfolio advice is an extension of passive investing. The cost is low and fixed (EUR 25 – 50 / month) and the portfolio is always 100% invested, long-only. However, the secret ingredient, which didn’t exist during Michael Jensen’s time, is targeted allocations i.e., actively changing the weights of the constituents in the portfolio to control volatility and maximize returns. These weights are selected via an advanced Machine Learning algorithm and have been shown to deliver better risk-adjusted returns than the equivalent index (see homepage).
With arty, you can benefit from the application of the latest financial technology without worrying about missing an opportunity or paying excessive fees.
- arty uses AI and big data to generate profit in any market situation,
- arty helps you to earn up to 25% annual returns,
- arty offers a selection of professional portfolios depending on your risk profile,
- arty helps you combine ETFs, which are great for reducing risk and creating stable, reliable returns.