Why many investment managers deliver poor results
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Most managers deliver poor results
Most investors who try to beat the market fail to do so. Being able to get into markets before a rise or out before a decline seems like a skill someone should have. Since much of the financial press is obsessed with where the market is going, it would be easy to think figuring out such movements were critical to success. Likewise, all the “what stocks to own now” story lines make many think that moving in and out of individual securities is the way to go.
That all makes for an interesting story and gives the market gurus plenty of airtime, but the overwhelming evidence tells us we don’t need gurus.
A recent look at the poor results of most money managers comes from Dimensional Fund Advisors[i]. Of the 2,587 mutual funds in existence on December 31, 2001 which invested in stocks of U.S. companies, more than half were shut down or merged with other funds during the next 15 years. When fund companies do this, the track record of the fund also disappears so rarely is a strong performer closed. Over that 15 years, a mere 17% of the original 2,587 funds beat a benchmark following the stocks in which the funds were invested.
Bonds are much more stable than stocks but that didn’t help fund managers much. Only 57% survived the 15-year period and 18% beat their benchmark.
Smart people competing with other smart people
How does this happen? Money managers are well-educated, well-equipped, and well-paid specialists, which is part of the problem. They are competing with other well-educated, well-equipped, and well-paid specialists to buy and sell a finite set of securities. Managers are paid to move money around in an effort to beat their benchmarks. They must get paid, their operations must be funded and the more trading they do, the higher the costs.
The Dimensional study clearly shows that funds which have higher expenses (due to fees and trading costs)on average have a poorer track record than lower expense funds.
Narrow is the norm
A second reason for poor results is described in a recent study by academics from the University of Chicago and Oxford[ii]. Periodically the press will lament how the market is “narrow” i.e. only a few stocks are doing well so we should be fearful if those stocks start performing poorly.
…most of the time market indexes are driven by a few stellar performers.
The Heaton study suggests this is not a newsworthy point as most of the time market indexes are driven by a few stellar performers. They looked at the performance of 26,000 stocks in the University of Chicago’s CRSP data base from 1926-2015 and found that “…58% of common stocks have under-performed the T-bill rate over their full lifetime. Moreover, the entire gain in the U.S. stock market since 1926 is attributable to only 4% of the stocks. The top 86 stocks have created a 50% lion-share of the total $32 trillion dollars achieved.”
Wow! That is narrow.
This happens because a stock can only lose 100% of its value but there is no cap on the upside. It makes sense that if you own the best of the best, you can do very well but the best is a tiny group. The practical lesson here is that the most reliable way to assure you own these superstars is to diversify as widely as possible and manage costs. This is one of the things we do for clients and what we expect of the funds we use.
Theory becomes reality
The results speak for themselves. Of the 16 Dimensional funds that existed over the 15 years ending December 31, 2016, the only one that did not finish in the top 25% of its category missed that top quartile by less than 1%[iii]. If the other fund families we favor ran similar studies, we would expect similar excellent results. Further, since most of these funds are also more tax efficient than the general fund population, we would expect them to rank even higher on an after-tax basis. A Morningstar study (Ptak, 2016) found a mere 4.1% of managers outperformed on an after-tax basis over 10 years. We want our clients to pay as little as possible in taxes, so tax efficiency matters.
We have been emphasizing the importance of diversification, patience, and discipline for a long time. These results reinforce all three of those points. Our research team looked at the year-to-year category averages[iv] from 2007-2016 of these same 16 funds. Even properly structured low-cost funds have rough stretches. All of the funds ended in the top 26% for the full ten-year span yet all experienced a bad year and most experienced several bad years. On average, each of the funds were below average in four out of the ten years.
There are a lot of things we can worry about but the quality of our clients’ holdings is not one of them.
News & Notes
Congratulations, Dan: Dan Moisand, CFP® was the recipient of a Jesse H. Neal award. The Jesse H. Neal awards are “…the most prestigious editorial honors in the field of specialized journalism. The Neal Awards were established in 1955 to recognize and reward editorial excellence in business media. Award-winning content reports on major industry issues of the time.” Dan was one of the writers for Financial Planning magazine’s coverage of the Department of Labor’s Fiduciary Rule.
Clients: Please remember to call us when anything significant happens in your life, including changes in your finances, family, or health that could affect your financial plan, please let us know so that we can adapt our planning and portfolio work for you accordingly. Also, if you ever fail to receive a monthly statement for one of the Schwab Institutional or TD Ameritrade Institutional accounts under our management, please let us know so we may assure the respective custodian delivers your statements promptly.
Yours truly,
The Team at Moisand Fitzgerald Tamayo, LLC
[i] “Mutual Fund Landscape 2017 Report”, Dimensional Fund Advisors
[ii] “Why Indexing Works”, Heaton, Polson, & Witte, 2017
[iii] “Relative Performance of Equity Funds With More 15 Years of History”, DFA 2017
[iv] Data from Morningstar website
