Be careful when interpreting statistics

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Be careful when interpreting statistics

By: Nesan Nair, Portfolio Manager, Sasfin Wealth

   

It is difficult to go through life these days without being bombarded by statistics, whether it’s the performance return on your share portfolio to the number of sixes AB de Villiers accumulates in a T20 match, we love to quantify our accomplishments.

And why not?                

We’re competitive creatures by nature and by quantifying our accomplishments, we set a benchmark by which to outperform at the next opportunity. After all, this is the definition of progress, and there’s no reason to make any apology for it.    

Accounting for the errors

Critically important though is actually understanding these statistics as sometimes they can be deceptively misleading. For example, I often hear clients and colleagues alike argue “I want to invest my money in a passive fund (i.e. an exchange traded fund or ETF), as research has shown that 85% of active fund managers don’t beat the index”.

 Sounds logical at first, until you drill a bit deeper:

  1. Firstly, 100% of ETFs don’t beat the index. Sure they’re invested in the index stocks, but they do incur management fees and trading costs, just as active funds do. The underperformance is marginal in most well run ETFs, but if it’s your investment objective to beat the index, there’s no way you would even consider a passive fund – rather take your chances on the 15% of fund managers that do beat the index.
  2. Secondly, we need to ask the question: should we be counting the percentage of fund managers that beat the index, or rather the percentage of investable funds that beat the index? The distribution of funds under management is disproportionate amongst the various fund managers with the top three managers (all of whom beat the respective market index over the relevant periods) holding more than 50% of investable funds. What does this mean? An investment of R100 into the active fund management industry is more than likely to have achieved a higher return than the index return. Surely this is a more relevant statistic if you’re deciding whether to invest in an active or a passive fund for the purposes of beating the index?

I’m sure you find this all very interesting, but the question still does remain: “when is it appropriate to invest in an active fund and when does it make more sense to go the passive route”.

Over the years, I’ve come to the realisation that this depends entirely on the level of sophistication of the investor or his financial adviser. For the novice investor, the ETF is the obvious choice as it gives you the required market exposure and the diversification you require. For the more sophisticated investors, particularly those with an investment bias such as a value-style investor, you’re better off with a fund manager that specialises in such a style you can identify with. The most important characteristic for any investment is to be able to understand it and in doing so, you be comfortable about its appropriateness to your individual circumstances.