Investors worried about a bear market should invest in tracker funds, according to a new report prod...
Investors worried about a bear market should invest in tracker funds, according to a new report produced in association with Virgin Direct.
The report's author, Simon Keane, professor of finance at the University of Glasgow, has found that active fund managers cannot consistently predict the start or duration of a bear market with enough accuracy to give them an advantage over trackers.
He concluded that over the long term, the buy and hold policy of index tracker funds is more profitable than adopting defensive measures in an effort to anticipate a downturn.
As evidence of this he cited the PricewaterhouseCoopers 1999 Management Survey. It showed that in the US during the last major correction in 1998, the average active manager underperformed the market by 2.5% on the downturn and by 5% on the upturn.
Keane said: "We are experiencing the longest period of consistent growth in recent history and like everyone else I am wondering when the bubble will burst. However, passively managed funds, on average outperform actively managed funds before, during and after a bear market.
"All the evidence shows that bear markets are unpredictable and the cost of trying to guess the direction will outweigh the occasional benefits. Even if downturns could be predicted, the ultimate strategy would still be to invest in index funds."
In the report, Keane has relied on research by the Journal of Finance which concluded that active investment strategies fail to perform better than a strategy based on chance. He said that if there are funds with superior prospects, the task facing the investor in picking the right fund is not less than the task facing the fund manager in picking the right shares.
It is the case that nearly all investors suffer a loss in a bear market. If downturns could be predicted, the appropriate strategy would still be to hold a tracker fund and take expert advice on a time to sell it.
Keane said he found no evidence that the phases of a bear market could be predicted. Instead, he contested that the balance of probabilities at any given time is that the market will rise by the normal rate of growth.
Even if defensive funds outperform trackers during a bear market, this does not make them a good investment, Keane argued. A bank deposit outperforms both when prices fall but Keane said that the issue is not whether being liquid in a market fall is beneficial but whether it pays to become liquid in the event that there may be a bear market. In this case, he argued that the evidence suggests the costs of a defensive strategy on average outweighs its benefits.
Keane concluded that the optimal investment strategy was to buy-and-hold the market portfolio.
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