ring, ring...
DOUG (ALPHAGLIDER CIO): Hi, this is Doug Kirkpatrick.
MARK (XYZ & ASSOCIATES SALES REP): Hello Doug, my name is Mark ABC from XYZ & Associates. Do you have time to talk about some of our new funds
2
that I think may be a good fit for your firm?
DOUG: We only use extremely low cost index ETFs in our investment strategies. If your funds won't substantially raise the 6-8 basis point cost of my strategies, then I do have time to talk with you.
MARK: Our funds only charge two.
DOUG: Only two? Please tell me more.
MARK: Well, two, two percent.
DOUG: Two percent?!? That's 200 basis points.
awkward pause...
MARK: Well yes, but we'll share it 50/50 with you.
DOUG: I'm sorry, but my firm doesn't take cash under the table from fund suppliers. Thanks for your call, but I'm not interested. Good bye.
This was the phone call I got this morning while I was writing this blog. It wasn't the first call I have received like this, and it probably won't be the last. Seems to queue up what I was writing about — the impact of fund fees on investor returns.
Last week S&P Dow Jones Indicies published its semi-annual review of US-listed, actively managed mutual funds — the
SPIVA® U.S. Scorecard
. It's a report dense in numbers and charts, but there are many interesting conclusions that come out of it. Here are a few:
Source: SPIVA® U.S. Scorecard, AlphaGlider
12.45% and 13.07% vs 14.70%: Average annual returns (asset weighted and equity weighted) returns for the 10-years ending June 30, 2019, for the field of domestic large-cap core funds, versus the S&P 500. The annual 1.63% to 2.25% (asset to equal weighted averages) relative underperformance is caused by fund management fees (e.g. Mark's 2% fund fee!), equity trading fees, bid/ask spreads associated with that trading, and negative alpha (poor stock picking). All but the latter cause will continue to weigh on large-cap core fund performance going forward.
$100,000 invested in the S&P 500 on June 30, 2009 would have been worth $394,125 on June 30, 2019 (14.70% annualized return). The average $100k investor in an actively managed large cap core fund got $52,560 less (13.07% annualized return). Ouch.
Source: SPIVA® U.S. Scorecard, AlphaGlider
351 to 248: The decline in actively managed large-cap core funds from June 30, 2009 to June 30, 2018. Fund management firms have frequently shut down funds over the decades, and this was the case over the last decade (147 of the 351 large cap core funds existing in 2009 were closed by 2019). The large majority of these fund closures were due to poor performance numbers. Over this past decade, fund management firms dramatically reduced the rate of new fund openings in the large-cap core category. This reflects the large shift in investor funds out of actively managed funds into index funds.
Source: SPIVA® U.S. Scorecard, AlphaGlider
Think it was just domestic large-cap core fund managers who had a hard time beating their bogey (i.e. index)? Think again. The chart above shows the split of under/overperformance relative to appropriate indexes for 18 different subsegments of the domestic equity universe.
Source: SPIVA® U.S. Scorecard, AlphaGlider
And lest you think it's just domestic equity fund managers who had a hard time beating their bogey, check out the above chart for actively managed global and international equity funds.
Source: SPIVA® U.S. Scorecard, AlphaGlider
And lest you think it's just equity fund managers who had a hard time beating their bogey, check out the above chart for actively managed fixed income funds. At least there were a few subsegments of the fixed income universe where a small majority of active managers beat their index over the last 10 years.
It's pretty clear from the above data and charts that few active managers are able to beat their respective benchmarks over long time periods. But there are some that do. So why not just invest in them?
Conveniently, S&P Dow Jones also tracks fund "persistence," that is the ability for historically strong performing funds to continue performing well into the future: The Persistence Scorecard (March 2019). Picking back up on the theme of domestic large-cap funds from above, the report's authors divided the universe of domestic large-cap equity funds with at least a five year track record as of March 2014 into 5-yr performance quartiles. Roughly speaking, only the top quartile was able to beat the S&P 500 over this time period. So how did these top quartile, better than index, funds perform over the subsequent five year period? Not so well.
Source: The Persistence Report, AlphaGlider
Less than 20% of these "top" funds were able to repeat their feat of being a top quartile fund. Put another way, more than 80% of these "top" funds either failed to beat the S&P 500, merged/closed, or strayed from their large-cap mandate, over the subsequent five year period (ending March 31, 2019). As they say, past performance is no guarantee of future results.
I left my career as a stock picker for Janus Capital in 2012 to start AlphaGlider. It was this type of data that led me to decided to build AlphaGlider strategies with low cost index exchange-traded funds (ETFs) instead of actively managed mutual funds.