At times it can be very hard to get to the truth in the investment field. Currently, it is very difficult to find a defender of active investment management. A recent study from Fidelity Investments, however, reminds us that it is important to hire good, active managers for your portfolio.
The study, completed in 2015 by Fidelity, confirms that from 1992 to 2014 U.S. Large Cap Active funds on average did under-perform their benchmarks. Passive funds, of course, are the benchmark. However, two simple objective filters revealed some very effective active managers. Keys were 1) low fees and 2) belonging to a large fund family.
The key findings in the study were:
- Even though the average U.S. Large Cap fund under-performed its benchmark during the period examined (1992 to 2014), the average fund from a large fund family exhibiting low fees outperformed both its benchmark and its long term average.
- Although 2015 was a tough year for active management, the average fund exhibiting the two selected characteristics outperformed its benchmark in 2015.
- When other asset classes were considered (Large Cap International Equity and Small Cap U.S. Equity) active managers on average outperformed their benchmarks without regard to either fund family size or expenses.
Here’s what investors should take away from this study:
- Investors may want to think twice before accepting industry average results as conclusive evidence.
- Variation in all biological phenomena (read human activity) can be explained by a bell shaped curve. Given any human activity some people will just be better at it than others. This is as true in investment management as in any other activity. When we look for active managers for our portfolios we don’t even consider “average” managers. We screen for those consistently in the top 25% of their peer group. In other words, we scan for the right hand tail of the bell shaped curve, the elite of the peer group.
- As with a lot of other activities, it helps to have resources. Investment management should be viewed as a team sport. In any team sport you can be the greatest athlete in history, but unless you have the resources that your teammates provide you will not win enough games to achieve lasting success. This is why fund managers at larger institutions with deep talent pools tend
- to outperform.
- Fees really do matter. This is why the less expensive active managers tend to be more successful. Less 0.79% in fund expenses was considered low cost for active management in this study.
- Some asset classes, because of the structure of their markets or lack of transparency and liquidity do not lend themselves to passive investing (indexing). A good current example is emerging markets. Investing in emerging markets can be done through index funds rather cheaply. The cost for Vanguard’s Emerging Markets Equity Index Fund ETF (VWO) is only .15%. However using this index puts your money to work in all emerging markets including those that we believe are permanently compromised by political misdeeds (Mainland China, Russia) and totally dependent on one or more commodities (Brazil). Common sense tells us that a little rational human thought in this area can go a long way in markets like these. This is why the Fidelity study found indexing largely ineffective outside of U.S. Large cap stocks.
Index funds and ETFs should be viewed as more choices in your investment tool box. If they are the right tool for the job, then by all means use them but do not fall prey to the misguided notion that they are always the better option.
You can find a copy of the Fidelity White Paper here: https://pyramis.fidelity.com/app/p/us/articleDetail?id=854
Wishing you a happy and prosperous second quarter of 2016!