These guys will probably perform better than your professional share managers, and they’ll work for peanuts.
Photo: Rob Homer
If it wasn’t bad enough that your super fund is a cash cow for politicians, a new study shows its share managers might as well be monkeys.
Researchers at London’s Cass Business School have found that share indices constructed on the basis of market capitalisation – the type that most fund managers benchmark themselves against and track within a few percentage points – produce much lower risk-adjusted returns than randomly-generated so-called monkey indices.
The Cass study took monthly performance data on 1000 US shares that traded between 1968 and 2011. First, the researchers constructed a regular market-cap weighted index for that period. They also constructed indices weighted according to each of several “fundamental” characteristics of the stocks – total annual dividend, total annual cash flow, book value and total annual sales.
Then they programmed a computer to randomly pick and weight each of the thousand stocks in the sample – effectively simulating the stock-picking ability of a monkey – and repeated that process 10 million times.
“The results of this experiment showed that many of the monkey fund managers would have generated a superior performance than was produced by some of the [fundamental] indexing techniques. However, perhaps most shockingly, we found that nearly every one of the 10 million monkey fund managers beat the performance of the market cap-weighted index,” says Andrew Clare, a professor at Cass who co-authored a report on the study.
“One of the implications of our work is that we should perhaps be benchmarking our fund managers against monkeys rather than against a cap-weighted index!”
The study is a gift to opponents of the market-cap weighted orthodoxy among professional managers of shares. The most common criticism of portfolios guided by market capitalisation is that they are forced to buy shares as they become more expensive, and compelled to sell them when they become cheaper.
Of the alternatives to cap-weighted indices tested by the Cass study, a portfolio worked best when it allocated more money to a stock, the higher its total annual sales. The sales-weighted index beat 99 per cent of the randomly constructed monkey portfolios over the 43-year period of the study.