'Monkeys' beat the stock market

Ten million portfolios containing stocks randomly selected as if by monkeys managed to produce better profits than a tracker fund over 40 years, academic research has concluded.

The tracker fund was made up of stocks weighted according to their share of the market, thus raising the question as to whether this is an appropriate strategy to build passive investment funds.

The majority of passive tracker funds are constructed this way. A tracker aims to mirror or "track" the performance of any of a number of worldwide stock market indexes, such as the FTSE 100.

A FTSE 100 tracker is proportionally invested into the 100 companies in the index based on how large those companies are - their market capitalisation. But the new research, conducted by Cass Business School and sponsored by Aon Hewitt, questions whether there is a better way to construct indices and the funds that track them.

So an index could instead, researchers suggested, be based on the size of the dividends paid by the companies or on "book value", which is the value of a companies assets if it were wound up and sold. Unlike market capitalisations, these measures are not inflated by market sentiment.

The study is based on monthly US share data from 1968 to 2011 and looked at 10 million indices weighted randomly. These "monkey" funds consistently delivered much better returns to the weighted approach.

John Belgrove, senior partner at Aon Hewitt, said: "While market capitalisation weighted benchmarks remain the bedrock to performance assessment and portfolio construction, this work sheds fresh light on the age-old active versus passive investment management industry debate.

“Inherent weaknesses in cap-weighted investment strategies are well documented, although they have been an enduring and challenging benchmark for active managers to beat. The good news for investors is that there is more implementation choice than ever to consider when selecting a preferred long term portfolio construction and fund manager style.”

Passive funds have become increasingly popular over the last couple of years as investors get fed up for paying over the odds for failure.

"Charges are an increasingly important factor for investors, and rightly so, as the greater transparency of fund costs is allowing investors to see more clearly how much they are paying for their fund manager's expertise," said Philippa Gee, a wealth manager. "While you might expect the annual fee of an active fund to be at least 1.75pc, or much higher for certain specialist funds, a tracker fee could be as low as 0.2pc, depending on which index it is covering."

Passive investment can be done using a tracker unit trust or exchange-traded fund (ETF). Trackers can be bought and sold like any other unit trust or Oeic via a fund platform. ETFs are listed on the stock exchange like a share.