Why Woodford is one in 2.3 million

In a previous life, I spent many hours trying to work out whether it was possible to help investors reliably pick actively managed investment funds. I looked at past performance, volatility, information ratios, you name it - but whatever formula we came up with never proved any good at predicting whether a fund manager would perform well in the future.

What our analysis did prove fairly conclusively, however, was that the vast majority of fund managers do not outperform the index over the long-run. And even those who outperform for a few years are normally lucky rather than skillful. As the regulator likes to put it, past performance really is no guide to the future.

Neil Woodford - the veteran income fund manager who this week set up his own fund management company - is the exception, who perhaps proves the rule. If you'd invested £10,000 in his Invesco Perpetual High Income fund when it launched 16 years ago, and had reinvested all your dividends, you'd now be sitting on a pot worth a little over £250,000 - that's growth of over 2,400%. The same amount invested in the FTSE All-Share index would be worth a little under £110,000 - not even half as much.

Looking at these kind of numbers, it's easy to get carried away searching for other managers with the talent of Woodford. But truth is, there are very few. Hargreaves Lansdown, one of the UK's largest fund brokers, compiles a list of active funds which it believes will outperform over the long-run. Although it calls the list its Wealth 150, there are currently just 90 funds on there - from a universe of thousands. Hargreaves - and its fund picking guru Mark Dampier - have a better track record than most at picking winning fund managers, but it has got it wrong many times as well. So to put it another way, out of those 90 funds, a good number will not live up to their billing.

Active vs passive

So if you're sitting on some money, and wondering where to invest it, should you bother with active funds at all?

When it comes to investing, the one thing you can count on is fees. And active funds are much more expensive than index trackers or other types of passive funds. Although a difference of 0.5% in annual fees may not sound like much, it can add up to thousands of pounds if you hold your investment for some years.

But when you look at how much better the likes of Neil Woodford have managed to perform, it's hard not to want to take a risk.

This week, Neil Woodford left Invesco Perpetual and set up his own shop, Woodford Investment Management. He promises to carry on doing exactly what he did at his previous employer - and better still, the charges will be less. I have some of my pension invested in Woodford's Invesco fund, and I'll certainly be following him to his new outfit. But I'm under no illusion that he's unlikely to be able to indefinitely deliver the returns he has done over the past 16 years.

Perhaps the most similar manager to Woodford on the other side of the Atlantic was a guy called Bill Miller, who outperformed the S&P 500 index for 15 consecutive years between 1990 and 2005. For the gamblers amongst you, the odds of doing that were approximately one in 2.3 million.

But when the financial crisis started to set in towards the end of the last decade, Miller fell to pieces. His old style did not match up with the new reality. And 15 years of outperforming made him overconfident. After 15 golden years, he then underperformed for five of the next six years - undoing much of his good work before finally retiring.

Anthony Bolton, one of our homegrown star fund managers, has also been ending his career in something of a funk after trying his hand at running a Chinese fund, and failing to replicate the kind of outperformance he'd managed back home (although he has managed to just about get his head above water again over the past nine months).

If Neil Woodford starts to go off the boil - as in all likelihood he will - I hope I'll see the signs and move my money first. But for the average investor who does not follow the market on a regular basis, active management is a dangerous business.

By all means put some money in Neil Woodford's new fund - he'll probably do very well for you. But make sure you spread the rest of it around a number of other funds too - and keep a good number of passive funds in there as well. While index trackers may not be exciting, they can't underperform in the same way that an overconfident fund manager can.

Enjoy Neil Woodford while you can. He's one in at least 2.3 million.