Why managed funds are a game of risk

The odds are stacked against actively beating the market. Dr Benjamin Holdsworth explains the costly challenges of active investment management.

As you will have seen in numerous media reports, Neil Woodford – one of the UK’s best-known fund managers – recently had to suspend trading in the actively-managed Woodford Equity Income Fund. 

At its peak, the fund held over £10bn of investments, but, at the time of writing, held less than £4bn. 

To summarise very briefly what went wrong, when the performance of the fund did not live up to expectations – Woodford’s previous successes had driven initial enthusiasm – investors began to lose confidence and attempted to remove their money. 

The subsequent exodus caused substantial problems because many of the investments could not quickly be turned back into cash. 

While the financial future remains uncertain for Woodford’s concerned investors, the key lesson to be learned is that active management adds additional layers of risk to portfolios. 

Risks worth taking?

In a world where markets work pretty well and active manager fees are high relative to likely skill, one should question whether these risks are worth taking. The Wood­ford case provides a useful reminder of the challenges and dangers of doing so.