How You Can Avoid Getting Lost in the Land of the Titans

In the beginning, fund managers didn’t worry about competition. In those happier times, the first big collective vehicles aimed at retail investors in the UK bought portfolios of 25 or so stocks, mostly with an income bias (the tastes of British investors have not changed), and typical managers did nothing but maintain the portfolio in “an administrative capacity,” says Nigel Morecraft in Towering Investors: The Origins of Asset Management from 1700 to 1960. They bought and they waited — mostly without much reference to what anyone else did. These professionals knew nothing of benchmarks. Their aim was to do better than inflation, cash or government bonds. Not so for the modern version, who is no longer allowed to think in absolutes or for the long haul. Instead, he must think only in terms of performance relative to one of the many indices to which his performance is benchmarked — over no more than five years.

That’s a terrible shame. That’s partly because relative performance is not what the average punter cares about: Our first hope is always that we not lose money, not that we lose less than a spreadsheet. It also puts the focus in the wrong place. If your main aim is not to do worse than an index (there are no bonuses in that!), something that tempts you to replicate much of the index in your portfolio, you will also find it hard to do better than that index. And sometimes you will find it harder than other times.

Now is one of those times, thanks in large part to the extraordinary dominance of megacap stocks in global markets, in the US in particular. Over the past 12 months the Dow Jones Global Titans index (the biggest 50 companies in the world) is up about 35%. The MSCI World Index (which is market-cap weighted and so biased toward the Titans) is up 21%. The equal-weighted version of the world index is up about 14%.

The biggest companies have been the only real out-performers and hence the thing to beat. Almost no one has managed it. Look over the last decade, says fund manager GMO and 90% of large-cap blend managers have underperformed the S&P 500 Index. Horrible. Look to the actively managed funds in the UK (of all types) says Alex Paget at fund-management firm Downing: 2.5% of them have outperformed the Titans in the last 12 months. The few that have made the grade have almost all had a US, growth and technology bias and have been overweight the biggest stocks out there.