Market Update 30th September 2024

Changes

I have a former employer who once invested £2m of his own money into an investment trust and forgot about it. Admittedly this was March 2020 and quite a lot was going on, but it seems unusual. The reason I remember it very well is the trust had fallen about 20% in the two weeks since we bought it and amongst other things, this meant someone had to go and tell him. (Reader, do not worry – it’s a long time ago and I’m okay now).

I was reminded of this last week when I saw a headline on social media which said that Fidelity had done some research into their own clients and found the best performers had either died or forgotten they had accounts. My first thought was this might make a good Innovation, but my second thought was that it didn’t pass a basic smell test.

Google tells me firstly that the headline is over a decade old, and secondly that Fidelity have strongly and repeatedly denied that the study was ever done, never mind that it came to this conclusion.

What the eye-catching headline is getting at of course is asset turnover and implies that managers are much better off doing nothing at all.

If you have a hit rate of anything over 50% in choosing investments, you are likely to be successful. The only other thing I can ever think of which is similar is baseball. A 0.3 batting average will make you a multi-millionaire hero to small children. That is just hitting the ball three times out of ten, not actually scoring. 0.4 is considered impossible. You’re not going to want a surgeon or a lawyer batting three out of ten.

When we ask funds about their turnover, they usually give a single number and I think the received wisdom is it should be some variation on “quite low”. Sometimes if the number is a bit higher, they will split out stock turnover from fund flows and say it is not as high as it sounds.

But if they are wrong close to 50% of the time and have “low” turnover – which might be in the region of 10%-20% let’s say, then that would mean they are likely to be sitting on a lot of losing positions.

There is proper academic research on this as well of course. The trouble with this is a lot of it comes to completely different conclusions. Some of it shows higher turnover is good, some of it shows it is bad, and pretty much everything else in between.

Rather than picking one to suit whatever I want to say, I picked one that partly goes into why there is so much divergence in the academic literature.

The paper “Do Funds Make More When They Trade More” was written in 2020 by Pastor, Stambaugh and Taylor.

It suggests the straightforward idea that funds are trying to trade in a way that maximises their profit. They sampled over 3,000 US equity funds between 1971-2011 and found a one standard deviation increase in turnover led to a 0.66% per year increase in performance.

The key point they make is that turnover is not a static number that applies equally to everyone all the time. It may be 40% say, over a year, but can be dramatically different at varying points in the year.

A good manager should be reacting differently when they see more or fewer opportunities and will maximise profit by increasing or decreasing turnover at the right time. A less good manager might not recognise these times and/or might not get the most benefit from increases or decreases in turnover.

Going back to March 2020 – this was probably the busiest I have ever been at work, and okay we got one wrong, but not much else. Then towards the end of 2020, the market had recovered and we pretty much ground to a halt. An average turnover number from these two extremes in less than a year wouldn’t tell you much and might even be actively misleading.

These arguments lead us naturally into the debate between active and passive. I came across some research showing that high active share managers tend to perform better – in other words managers who take bigger positions away from the benchmark, backing themselves to do well. It’s a different kind of activity than turnover, but again supports the idea that the ones who are good at it should do more of it. More can sometimes be more.

Robert Fullerton – Senior Research Analyst

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