The following is a great piece of commentary by Weston Wellington from Dimensional in the US. Please note that the references are to US data but the results have been translated into the Australian context through a recent report prepared by Standard & Poors.
Enjoy the read.
Report Card for Active Managers
Morningstar recently announced the introduction of a new "Box Score" report analyzing the performance of actively managed US equity mutual fund managers. Morningstar's analysis starts with a universe of 22,000 US equity funds and prunes the list by aggregating multiple share classes and eliminating exchange-traded funds, sector funds, bear market funds, long/short funds, and lifecycle funds. They also exclude funds deemed to have a "passive-like" investment approach, specifically citing Dimensional strategies. All funds available for purchase at the beginning of any particular time period under review are included, so the results are free of survivor bias. Morningstar compares results to their own stock indexes, which seek to capture the returns of the nine distinct Morningstar style boxes (large cap growth, mid cap value, etc.), and evaluates performance by calculating both Jensen's alpha and a more comprehensive Fama/French alpha.
The report is similar to the SPIVA report (Standard & Poor's Indices versus Active Funds Scorecard), which compares actively managed funds to various S&P and Barclays indices in US equity, international equity, and fixed income markets. S&P uses the CRSP Survivor-Bias-Free US Mutual Fund Database, and, like the Box Score report, is published semiannually.
Although we found the Morningstar report rather light on documentation, both reports are useful in providing a regularly updated analysis that quantifies the challenge facing investors seeking to identify winning money managers.
A few nuggets from recent reports:
Morningstar finds that 41% of actively managed funds outperformed their respective indexes for the three-year period ending June 30, 2009, using a measure of Jensen's alpha. But Morningstar notes that "once the Fama/French factors are taken into account, active managers' outperformance relative to the indexes falls materially." By the latter measure, only 37% of managers outperformed, and average alpha was negative in all nine style categories.
S&P reports that only 31% of large cap core funds for the five-year period ending June 30, 2009 outperformed the S&P 500 Index. Results were even less favorable for non-US markets, where 13% of international funds and 10% of emerging markets funds outperformed their respective benchmarks. We often hear that non-US stock markets exhibit greater pricing errors than the US, supposedly offering a target-rich environment for clever stock pickers. The numbers suggest this is wishful thinking.
Fixed income markets were no less challenging: for the same five-year period, Standard & Poor's found that 22% of intermediate government funds were outperformers, and the number dropped to 11% for high-yield bond funds and only 2% for mortgage-backed securities funds.
The fund attrition rate is significant: S&P reports that 27% of the 2,154 US equity funds in existence five years ago have merged or liquidated as of June 30, 2009. For reasons unclear to us, the number jumps to 39% for large cap blend funds, the worst among all style categories. Morningstar reports that 10% of small growth funds have disappeared in just the first six months of 2009.
Both reports can be downloaded from their respective publishers at no charge:
The Morningstar Box Score Report: Alpha Seekers, Caveat Emptor, First Half 2009.
Standard & Poor's Indices versus Active Funds Scorecard: Midyear 2009.