Beating the Market, an Elusive Goal
analysis, mutual fund, value investing

Contrary to the main thesis of an article in The New York Times and despite emphatic proclamations, beating the market remains an elusive goal. A mutual fund manager, Robert A. Olstein, featured in the article, finds the arguments for index funds personally insulting:

“It’s like saying mediocrity is O.K. — that it’s more than O.K., it’s the best that anyone should hope for,” Mr. Olstein says. “It’s saying a guy like me can’t beat the market — that he shouldn’t even bother trying. That’s wrong! It really ticks me off. I can beat the market. I have beaten the market.”

To verify this statement, let’s take a closer look at the performance record of his Olstein All Cap Value (formerly known as Olstein Financial Alert). First, some information about cost. Class C shares of the fund (OFALX), established in September 1995, carry a hefty 2.31% expense ratio, including a sizable 12-b1 fee of 1%. In addition, there is a 1% contingent deferred sales charge (CDSC) imposed if an investor redeems Class C shares within the first year of purchase.

The Adviser Class shares (OFAFX), which became available four years later, have an expense ratio one percentage point lower than Class C shares. However, as their name implies, these shares are available to individual investors only through investment advisers who typically charge 1% in advisory fees. Therefore, from an individual investor’s perspective, the cost of both classes of shares is comparably high, which makes it difficult for the fund to outperform on an after-fee basis.

Second, there is an issue of a proper benchmark for the fund. As its name suggests, the fund pursues undervalued stocks in a broad spectrum of market capitalization. Yet its primary prospectus benchmark is the large-cap S&P 500® index (the secondary benchmark is the Russell 3000® index that includes smaller-capitalization stocks). Historically, Morningstar classified the fund into the mid-blend category; only in 2010 did the category change to large blend. As of the end of October 2013, about 40.2% of the fund’s holdings were still in the mid- and small-cap equities.

Third, the article states that

From its inception through November this year, including fees, his flagship fund returned 10.7 percent, annualized. That’s more than 2.4 percentage points better than the Standard & Poor’s 500-stock index, and substantially better than comparable small-cap indexes.

The problem is that this outperformance mostly stems from a relatively short period in the fund’s 18-year history. Here are the cumulative returns of the fund and the S&P 500® index in various periods:

From Through Fund Benchmark
1995 1999 166.9% 171.4%
2000 2003 45.6% -19.7%
2004 2006 30.6% 34.7%
2007 2010 -13.6% -3.3%
2011 2013* 46.5% 53.0%

*through December 6

The above data show that the fund’s lifetime outperformance of its primary benchmark can be mostly attributed to a relatively short four-year interval from the beginning of 2000 through the end of 2003. In other periods, the fund’s returns were sub-par.

What about risk-adjusted performance of the fund, determined with the simplest (single-factor) approach? Here are the fund’s Sharpe Ratios vs. those of its primary and secondary benchmarks implemented by the SPDR® S&P 500® ETF (SPY) and SPDR Russell 3000® ETF (THRK), respectively:

Period OFALX SPY THRK
3 Years 1.12 1.36 1.31
5 Years 1.09 1.10 1.13
10 Years 0.30 0.46 0.48
15 Years 0.41 0.24 N/A

The Sharpe Ratio figures corroborate our cumulative return findings: a more recent performance of the fund was also unimpressive on a traditional risk-adjusted basis.

The following Alpholio™ chart illustrates a relative performance of the fund vs. its reference portfolio of exchange-traded funds (ETFs):

Cumulative RealAlpha™ for OFALX

In this analysis period spanning almost nine recent years, the cumulative RealAlpha™ of the fund exhibited a mostly downward slope. This indicates that the individual stock picking skills of the management team left a lot to be desired. In addition, the annualized volatility of the reference portfolio was slightly lower than that of the fund.

Here is the dynamic composition of the fund’s reference portfolio in the same analysis period:

Reference Weights for OFALX

The fund’s top three equivalent positions were in the Guggenheim S&P 500® Equal Weight ETF (RSP; average weight of 24.8%), Vanguard Consumer Discretionary ETF (VCR; 19.3%), and SPDR Russell 3000® ETF (THRK; 8.6%).

In conclusion, the fund did indeed beat the market, but only in terms of returns and mostly in one, relatively short and long-ago period of its 18-year lifespan. The fund’s performance after adjustment for risk, using either a traditional approach or the modern Alpholio™ methodology, has been quite unimpressive. Thus, beating the market, at least for this fund’s manager, remains more a fleeting gain than a solidly reachable goal.

To learn more about the Olstein All Cap Value fund, please register on our website.


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Funds Again Outperformed by Benchmarks
mutual fund

The semi-annual report from S&P Indices Versus Active (SPIVA®) once again demonstrates that the majority of mutual funds were outperformed by their benchmarks over the one-, three-, and five-year periods to June 30, 2013. Here are the statistics for the US equity funds

SPIVA® - Percentage of US Equity Funds Outperformed by Benchmarks

and global/international funds

SPIVA® - Percentage of International Equity Funds Outperformed by Benchmarks

The only category where active management prevailed was international small-cap.

The situation was similar in fixed income:

SPIVA® - Percentage of Fixed Income Funds Outperformed by Benchmarks

Over the five-year period, the investment-grade intermediate and, to a lesser extent, global income were the only two categories in which, on average, active management provided superior returns.

While valid, the above results paint only a partial picture of funds’ performance: the returns but not the risk. In contrast, Alpholio™, through its RealAlpha™ measure, clearly demonstrates how much value each fund added or subtracted on a truly risk-adjusted basis, i.e. with respect to a dynamic reference portfolio of exchange-traded products (ETPs).

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Doubling Returns in No Time
mutual fund

An article from MarketWatch points out that thanks to the financial crisis of late 2008, five-year annualized returns of mutual funds are about to roughly double, even if incremental returns through the end of 2013 are nil:

MarketWatch - What a Difference a Few Months Make

This will undoubtedly lead to a marketing promotion from fund companies and advisers touting the five-year “performance” of funds in absolute terms. Moreover, absent a major downturn, numbers will look even better in about six months from now, when the trailing five-year period starts at the market’s bottom in early 2009 (re: S&P 500®’s close at 676.53 on March 9 that year).

Investors focusing solely on fund returns in isolation of relevant benchmarks make a classic mistake. Luckily, Alpholio™ can help: not only does it provide a custom benchmark for each analyzed fund, but it also makes this reference portfolio dynamic, truly adjusting for an ever-changing risk taken on by the fund over the analysis period. Therefore, from Alpholio™’s perspective, the passage of fifth anniversary of the onset of the financial crisis is irrelevant.

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