In a recent publication by a reputable financial news team, it was pointed out how well smart beta funds performed over the one-year period ending 30 June 2018. For simplicity sake, we will refer to smart beta funds as those that employ quantitative algorithms to make stock selections and calculate their corresponding weightings. Generally, they also charge a lower fee than their active “alpha-seeking” peers. Alpha can be generalized as outperformance of the market index. Looking at performance data for the General Equity Sector ending 30 June 2018, 6 of the 10 funds that outperformed the market over a one-year period were smart beta funds. However, a more complete story is told in the table below:

Smart beta funds that outperformed:

Using only a one-year performance history will result in flawed investment decisions. Some smart beta funds have underperformed over five years by such a wide margin that, considering the one-year outperformance, the other 4 years’ performance must have been horrendous.

Non-Smart beta funds that outperformed:

There appears to be only one active fund that consistently scored above the market index (Active Fund X). The challenge was that there were 223 funds to choose from at the beginning of the five-year period. It is the fortunate investor indeed who invested in this fund beforehand. Furthermore, research suggests that history is not a reflection of the future when it comes to fund performance. Active Fund Y underperformed for the first 4 years and Active Fund Z has a longer-term underperformance of 2.76%. Passive Fund G has consistently tracked the market return!

Ultimately, what we are saying is that investors need to ensure that they capture a substantial part of the market performance to grow wealth over the longer term. Consistently protecting yourself against underperformance means consistently earning a return closest to the market return.

How does one do this? Simply make use of a passive fund that successfully tracks the market performance over the longer term at the lowest Total Investment Charge (TIC).