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Active Fund Managers...Another Poor Showing

Updated on August 2, 2012

To Index Or Not To Index ???

Earlier this year the S&P released its most recent SPIVA scorecard found here

This is a scorecard that tracks the success of mutual fund manager relative to their corresponding benchmarks. Not surprisingly the results yet again do not favor active equity managers. While in previous articles, I have stressed the importance that asset allocation plays in overall portfolio performance (See below link), it is still important to examine the underlying investments that are applied to that allocation. With the exception of the growth in alternative asset class funds such as Long/Short or Market Neutral, the track record of active managers remains simply pathetic !!!

On a longer term basis what is interesting is that the few managers in the minority whom have been able to beat their corresponding benchmark still are not as successful as they appear. First let’s look at the track record of consistency. In the 1980’s the fund of choice was the Fidelity Magellan, which at that time was managed by Peter Lynch. While Lynch was a very sharp portfolio manager, since his exit the fund has fallen to one of the worst performing actively managed funds in the industry with a terrible one star rating from Morningstar. In the 1990’s the talk of the town was the Legg Mason Capital Management Value Trust run by the recently retired Bill Miller. They had a track record that beat the S&P for 15 straight years. Shortly after the investment community jumped on the ban wagon, the fund’s performance declined so much that during the 2008 market crisis they missed the S&P’s benchmark for a large cap fund by an amazing -18.05% for a total decline of -55.05%. Today it is just another 1 star rated fund. These are just a few examples of the revolving door of active equity manager performance. The reason this is important to note is that often financial advisors will combat the data above produced by S&P with the notion that they will be able to select the few active managers that will be above the benchmark going forward. Yet how many investors have had advisors tell them about Magellan before it was Magellan. More importantly, how many warned you that Magellan was no longer Magellan, or that LM Value Trust would miss the mark by such a wide margin that it wiped out the 15 year track record of success. My guess is that it’s very rare.

Look a little deeper at some of the more recent success stories. Over the last ten years one of the better active large cap equity managers has been Donald Yacktman of the Yacktman funds. His Yacktman Fund has outperformed the S&P 500 as of 6-30-2012 over the last 3 years with a return of about 18.30% vs the S&P 500 of about 16.40%. But a closer look tells us that due to portfolio turnover his after tax return if you simply held the fund was dropped to 17.55%. If you follow some basic principles of financial planning and intend to rebalance your portfolio over time, the added tax cost to you brought you down to the same level as the S&P over the last three years. And this is with a fund manager above the benchmark. Guess what those returns would look like when the manager is below the benchmark to start ??? As the SPIVA report indicates, it wouldn’t be good.

Mutual funds play an important role in terms of diversification…active managers do not. In fact the reality is there is no academic data that shows any consistency among active managers beating their benchmark in any area of mutual funds investing, with the exception of alternative assets. Alternative investments are an area that should NOT be jumped into by a novice without a thorough understanding of their proper use. For more information on alternative asset classes read the below link

There are various reasons for this dismal performance. Among them is the efficient market hypothesis, the cost structure of active managers (both disclosed & undisclosed expenses), portfolio turnover/tax liability & manager turnover.

The reality is that the investment universe has become in many ways more efficient. While this speed and efficiency has helped contribute to volatility to a small extent, the overall benefit to the consumer is substantial. As a result, many advisors have accepted more of an asset based fee only model when working with clients that will allow them to engage in more tax efficient and cost effective vehicles like ETF’s and index oriented solutions. Yet there is still a universe of classically trained sales people who for a large enough commission will sell you on the latest and greatest fund manager. In reality any financial planner working on portfolio construction knows that the focus of the investment plan is always allocation first. Adding “Alpha” to a portfolio is next to impossible. Investors looking for more detailed information on the academic research in this field, I would encourage readers to look closely at the work of Eugene Fama & Kenneth French and their Three Factor Model. This was some of the best work in terms of expanding on the Capital Asset Pricing Models.

As an investor you are a consumer. Like any other consumer you should always question the incentive of the person selling you the product or service. As a result of this and personal industry experience, I support the fiduciary standards for advisors dealing with the public as well as the fee only platform. Without any form of compensation to deter me from looking out for the best interest of my clients, I must then accept the academic work available for what it reveals rather than the sales pitch of someone with a silver tongue.


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