Alan Steel: So do old wives tales really help you find the best to invest?

Having just officially qualified as an angry old man, I hope I can be forgiven for reminiscing about my younger days. While I’m at it, I think I’ll also have a swipe at those who write about investments and regurgitate stuff that might have made sense once upon a time, writes Alan Steel

Once upon a time, I had grannies. Grannies are important. They’re great sources of wisdom. My grannies let me into a few secrets which served me well over the years. Pearls of wisdom like “You never know what’s in front of you” and “Once you get a reputation for getting up early every morning, you can sleep in all day”.

Some years ago, another wise old head – this time in the investment world – said: “Always ask yourself, what do you believe to be true that’s actually false?”

Let me give you a couple of examples. Like an old rickety pier I know in Florida, I was established in 1947. Since then there have been nine occasions when the US budget surplus has peaked and then fallen. And there have also been exactly nine occasions when US budget deficits have peaked and fallen.

Now, we’re constantly told that deficits of any kind are bad for stock markets.

But let’s check the facts. Take the so-called good guys first – the surpluses. The average three-year cumulative performance of the US S&P 500 Index with dividends reinvested, since 1947, is only 9.2 per cent.

The worst performance is from the peak surplus of 1999, when over the next three years the Index fell, including reinvested dividends, by 40 per cent.

Now let’s look at the so-called bad boys – the deficits. The average three-year cumulative performance in the same index, after deficits peaked, is 36 per cent, while the best three-year period was from the beginning of 2003 – up 38 per cent. Some difference.

Here’s another one truism that’s actually false: “Don’t invest in active funds because you can’t beat an index.” More specifically, we’re always told that 85 per cent of fund managers cannot beat an index, presumably leaving only 15 per cent who can.

I don’t know where this number comes from, because it’s been the same statistic over the last 17 years. Does anybody ever check the numbers? Last week somebody in a national newspaper repeated this myth – 85 per cent of managers can’t beat the index, so just invest in trackers.

I checked the numbers. I looked at UK Equity Income fund managers and their performance figures over the last ten years compared to the total return from the FTSE. It turns out 67 per cent of managers beat it – that’s over four times as many.

But what’s in an index? It’s made up of loads of shares taken from a wide range of sectors and is typically dominated by a few mega-companies. Did you know that the capital value of three companies in the FTSE is 40 per cent greater than the 50 least valuable shares?

On any given day 50 to 60 per cent of the shares may fairly reflect the value of the companies, and the rest are either grossly overvalued or undervalued.

What’s the best way to make money? According to Warren Buffett, it’s simply to buy cheap and sell high. That’s what the best fund managers do. They don’t try to match an index because they don’t want the overvalued stuff. Actually if you think about it, a tracker effectively buys high and sells cheap.

Here’s a final thought, though – if it were indeed the case only 15 per cent of managers beat an index, why not just invest with them? Take Neil Woodford, for example. His Invesco Perpetual high income fund beats the pants off the FTSE – it’s up 144 per cent in ten years, compared with the FTSE’s 60 per cent total return over that period.

Billions of folks’ hard-earned savings lie wasting away in trackers because of false beliefs. I know where my grannies would invest.

• Alan Steel is chairman of Alan Steel Asset Management