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Everybody claims to admire Warren Buffett, but almost nobody emulates him. Unlike active unit trusts, where the portfolio manager searches the market for the best stocks or bonds, an index fund passively replicates the performance of a particular index. This outperformance is largely due to the constant trading (churning) which occurs within most unit trust portfolios, in a mostly futile attempt to outperform the stock or bond markets. The high trading commissions and related fees most unit trusts incur coupled with the narrow portfolio focus on only a limited number of stocks or bonds - more often than not, ensures a weaker performance than the selected index benchmark. There is a minority of unit trust managers whose performance does exceed those of index funds – but identifying them ahead of time is incredibly difficult.
Using index funds and exchange traded funds (ETFs) as the core elements in global portfolio asset allocation models, continues to gain widespread popularity. In the US and Europe approximately 30% of all pension fund assets are now invested in index funds. CALPERS the world’s largest pension fund commonly indexes 25-30% of its almost $200bn California State pension portfolio.

Outperforming
The majority of South African and international fund managers consistently underperform the market indices. In 2006, the JSE All Share Index as measured by the SATRIX 40 ETF, outperformed all but a small handful of South African unit trusts.
The Standard & Poors (S&P) 500 outperformed nearly 70% of large cap fund managers in the US during 2007. (69.1%). In fact, index mutual fund inflows accounted for almost one quarter of total US mutual fund inflows.
The latest data compiled by S&P for 2007, once again shows that the vast majority of US unit trust managers underperformed their respective index benchmarks over the past one-, three- and five-year periods. This is true of large-cap, mid-cap and small-cap categories in the US market. Over the past five-year period, 72.2% of US large-cap managers failed to beat the S&P 500 benchmark, while 77.4% of mid-cap managers suffered a similar fate underperforming the S&P 400 mid-cap index. Similarly 77.7% of small-cap managers failed to beat the small-cap S&P 600 benchmark.( March 2007- S&P).
Over the past three years, the numbers do not look much better with fund managers underperforming as follows: 66.7% failed to beat the S&P 500, 65.1% underperformed the S&P 400 mid cap and 80.6% were trounced by the S&P 600 small-cap benchmark.
Not surprisingly index funds and their ETF cousins are increasingly used internationally as the core portion of a client’s portfolio. While active fund managers clearly have an important place, internationally they are more often selected to only add value in niche or satellite areas of the investment universe (such as different market sectors or specialised industries) .
Outside of the US, on the global investing front the news is not much better for fund managers’ performance relative to their index benchmarks. Over the past three years, the S&P Emerging Markets Index has beaten 85.1% of fund managers relative to the S&P/IFCI benchmark, while 73.3% of fund managers underperfomed the global benchmark (S&P/Citigroup PMI,) representing all markets outside the US.
Even on the fixed income (bond) side, during 2006 seven of eight US fixed income indices outperformed active fund managers’ global markets.
Those who list top-performing unit trusts as evidence that indexing doesn’t work are in fact doing investors a terrible disservice – despite a small minority of active unit trusts beating the indices, finding them in advance and ensuring that their performance is always consistent is another matter entirely.
Index funds when used as a core portion of either a local or a global portfolio, provide the necessary diversification and low costs to complement active fund managers. As Mark Twain says: “There are two times in a man’s life when he should not speculate: when he can’t afford it, and when he can.”

Anthony Ginsberg – Director
Lisa Segall – Director
GinsGlobal Index Funds Ltd

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