When you see a headline about a piece of research on Indexing Vs Active Management from an organisation like Financial Express, you’ll expect that research to be thorough, meaningful and to add a little to existing body of knowledge. Instead this latest research by FE Trustnet on the subject is a piece of unintelligible garbage, based on flawed methodology and lousy conclusions. It adds NOTHING to the debate. As an FE Analytics user and generally a fan, I feel a bit let down 🙂 (not really)
The first big flaw is that it completely failed to account survivorship bias and new fund launches and the best explanation Trustnet could come up with is ‘unfortunately survivor bias is impossible to measure using our data.’ (Update 24/01 – Since writing the initial post, I have been reliably informed by FE that this statement by one of their journalists is inaccurate and that their data does infact account for survivorship bias. That’s helpful, although I remain of the view that the methodology of their research is significantly flawed)
Really? Well then I suggest perhaps FE should get the survivorship-bias free data from their competitor Morningstar, who seem to able to provide this, at least to their institutional clients.
And in case you’re wondering how much of a difference this makes, survivorship bias-free data from Morningstar shows that;
- Of around 36,500 funds domiciled in Europe (as at April 13), 12,918 or (35% of current universe) have only been launched since the start of 2008.
- Between Jan 2008 and Dec 2012, 17,837 Europe-domiciled funds (or whooping 48% of the current universe) have been eliminated, either through merging or outright liquidation.
- Of 2,829 UK domiciled funds (as at April 2013), 34% of the current universe have only been launched since 2008 and around 37% of the current universe has been closed between 2008 and 2012.
Now, please explain to me why IMA Sector Average, which ignores that fact that over one third of its components died along the way and another one third was introduced along the way, can be used as a basis for this so called ‘research?’
Trustnet also suggests that ‘survivor bias is relevant for both active and passive funds.’ Whao! You seriously couldn’t make that up, except that it was totally made up. If you think survivorship bias affects active and index funds to the same degree as to make it irrelevant, you must be having a laugh.
The second flaw in Trustnet’s research is how they chose the index funds used in their research. They selected only index funds launched 10 years ago or before then. Even in their 1yr, 3yr and 5-year comparison, Trustnet ignored all the index funds introduced during that period. By comparison, using IMA Sector Average for the active equivalent mean they aren’t unable to pick and choose only active funds with 10 year track record or more. Meaning, they are comparing apples with grapes, never mind the fact that some of the best development in the UK index fund sector took place only in the last 7 years or so, including notable the arrival of Vanguard, Dimensional etc.
You know, it 12.30AM and I should go to bed right now but I will make this third and final point – Trustnet lumped all funds in the UK Equity Sector into one big group and compared them with passive funds tracking the FTSE All Share or FTSE 100. What a load of tosh? That ignores cap/style and other factor tilting such as value, growth, income etc. Off course, what Trustnet should have down is to group active funds based on the comparable indices specified in their prospectus and then compare with the corresponding index funds.
I guess the point Trustnet was trying to make is that not all index funds are the same and there are index funds charging same and even more that active funds. But by using the worst sample on index funds launched over 10 years ago to make a lousy point about active management, they effectively shot themselves in the foot.