While the numbers have yet to be finalised, 2019 seems to have been a particularly bleak year for active fund managers, with estimates by Bank of America that fewer than a third were able to beat their benchmarks. Even clearer is that the longer the time frame, the more prone fund managers are to underperforming. In the last 15 years, for example, 92 per cent of large-cap funds were outperformed by the S&P 500. Investors have voted with their feet: in the year up to June 2019, money was pulled out of active mutual funds at the highest rate in three years, much of it ending up in low-cost passive index trackers. Defenders of active management were often able to answer critics by highlighting the performance of certain star managers, fabled for their uncanny ability to consistently outperform the markets. In Britain, that star power was exemplified by Neil Woodford, as close to an emperor of the investing universe as you were likely to find. He was famous for turning an initial investment of £10,000 (US$13,000) into £250,000 (US$326,000) over more than 25 years at the investment firm Invesco Perpetual. But a closer look uncovered that this emperor was not wearing any clothes. Woodford’s flagship fund, launched in 2014, was eventually suspended in 2019 following massive losses and investor withdrawals. In the meantime, Woodford pocketed £9 million (US$11.7 million) in dividends for that year. These events have rightly tarnished the reputation of star stock-pickers and shone an unflattering light on the performance of investment managers generally. As this record-breaking bull market ages , some analysts nevertheless believe that active managers will be able to outperform their benchmarks during a period of more modest returns. But on this front, history is a cruel yardstick. Just 44 per cent of active managers outperformed their benchmarks during the 2008 global financial crisis, whilst barely 50 per cent managed that during the dotcom crash a few years earlier. More recently, over 80 per cent of British fund managers failed to beat the British index in the year up to June 2019, a period of severe market declines. What exactly is going on here? Fund managers are generally highly educated, highly trained and, needless to say, highly compensated. It seems natural to assume most of them should be able to beat the market. A recession may be fund managers’ last chance to prove their worth But it is worth noting, first of all, that outmanoeuvring the market is in fact incredibly difficult. Research has shown that the best-performing 4 per cent of listed companies accounted for the entire net gain in the United States stock market from 1926 to 2017. The remaining 96 per cent performed no better than US Treasury bills . International stock markets produced similar results. Any fund manager lucky enough to identify and stick with these slim pickings would have been able to stake their entire career on them. For the remainder, failure was close to inevitable. Furthermore, fund managers remain far too focused on short-term goals. The investment research company Morningstar last year found that the turnover ratio – the percentage of holdings replaced over a defined period – for managed US stock funds was 63 per cent per year. Research has consistently demonstrated that missing just a few of the best-performing days in the markets can have devastating effects on an individual’s portfolio, even over periods of several decades. Timing those days is simply impossible, yet this appears to be exactly what active managers are trying to do. Some of the blame must also be put on fund advisers, who have a terrible track record when it comes to profit forecasts. By the count of Morgan Stanley in 2016, forecasts for US companies’ total annual earnings per share made in the first half of the year had to be later revised down in 34 of the previous 40 years. More recently, the fund supermarket Hargreaves Lansdown was heavily criticised for including Woodford’s fund on its best-buy list right up until withdrawals were blocked. This cosy relationship between fund managers and fund advisers must come to an end. Lastly, we shouldn’t underestimate the importance of luck. Even if a fund manager is able to beat the market for several decades, their gains can be wiped out by a few bad years or, indeed, a single mistake. Star managers in particular face enormous pressure to outperform, which can only be achieved by taking ever higher risks. Woodford’s prolonged period of outperformance must now be at least partly attributed to downright good fortune. But as the famed US investor Warren Buffett once said, “you find out who is swimming naked only when the tide goes out”. David Ogilvie is a risk management consultant and freelance writer