《每日电讯报》投资者是自己最大的敌人

Most investors exacerbate poor returns from their funds by buying and selling at the wrong time, says Terry Smith.

Michael Johnson, the former American sprinter, once said: “The only one who can beat me is me.” I suspect that this statement simply demonstrates a lack of modesty, but it can have another, subtler meaning: that even if we are good at what we do, we are capable of producing a bad result because we allow our own emotions to defeat us. So often we are defeated not by our competition or the difficulty of the task but by our own psyche.

In investment it is easy, and indeed accurate, to criticise the poor service which much of the fund management industry provides to investors and to identify this as a major reason why investors get such poor returns.

Most managers do not regard the biggest threat to their career as losing investors’ money or performing badly. They regard the biggest threat as differing from their peers. The only thing that they regard as worse than failing is standing out from the crowd.

Never mind that they and their fellow fund managers produce dire results for investors, if they all perform roughly the same they are unlikely to see mass withdrawals by savers or get fired from their jobs. This leads the majority of “long-only” fund managers (those who do not use the sophisticated techniques of “short-selling”) to buy so many shares that they more or less replicate the performance of whatever index is their performance benchmark. I say “more or less” but the reality is that they mostly produce less.

If a fund manager owns enough shares to roughly track an index – and you don’t need more than about 25 randomly chosen shares to do so in most markets – their fund will underperform the index once it has suffered from the fund manager’s fees and the cost of his or her dealing activity. This outcome is as inevitable as it is poor.

I have lost count of the number of investors who have told me that they have withdrawn their savings from a long-term savings plan or personal pension only to discover that the amount realised is approximately the same as the amount subscribed over many years or decades, any gains that were realised having been swallowed by fees. One investor I know claims to have gained more from compensation from mis-selling than from the investment returns on her savings.

The situation doesn’t appear to be any better with hedge funds. The HSBC Investment Funds Performance Review shows that on average hedge funds have underperformed the market for five years in a row. One of my colleagues who recently applied to withdraw his investment from such a hedge fund was asked why.

He said it was due to the poor performance, to which the fund manager responded that almost all hedge funds had underperformed in recent years. Perhaps unsurprisingly, this did not provide much comfort. It’s that herd instinct again. The fund managers feel that they can justify their position if they all fail together.

Collectively, fund managers ignore Sir John Templeton’s axiom that “If you do what everyone else does, you will get what everyone else gets”.

As a result of all this groupthink, the average US fund investor over the past 20 years has earned a return of 7pc a year below the market (Dalbar Statistics) because of poor performance of the fund, fees and their own poor timing.

There is not much point in trying to negotiate your way around the poor performance of the fund management industry if you are going to make matters worse by your own actions. And we are certainly capable of doing that even when the fund manager does well.

Between 2000 and 2010 the best performing US fund was the CGM Focus fund, which delivered annualised returns of 18pc a year. Mightily impressive. Over the same period the average investor in the fund lost 11pc a year. Investors showed an unerring ability to buy into the fund at its peak in valuation and sell out at its troughs.

The vast majority of us are terrible at so-called “market timing”, in which investors try to sell at or close to market peaks and buy at market lows. All the statistics about investor flows show that believing you can accomplish this feat is the triumph of hope over experience. The wisest investors who are most likely to get the best performance are those who have at least realised that they can’t do this successfully and so don’t try.

The other major fault that most investors have, whether private investors or professional fund managers, is that they are too active – they deal too much.

Leaving aside the fact that if our timing decisions are almost all bad we would be better off making as few as possible, all dealing activity has a cost, much of which is hidden. We are taught that to be successful investors we need up-to-the-minute information and the ability to deal instantaneously. In fact, nothing could be further from the truth.

We should instead emulate the favourite client of fund manager Jonathan Ruffer, who said that “he would be monitoring performance on a quarterly basis, and if, after the first 25 years...”

It is a sobering thought: the fund management industry may serve us badly as investors, but there is one thing more detrimental to our wealth than that – us.

Terry Smith

The Telegraph