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
and global/international funds
The only category where active management prevailed was international small-cap.
The situation was similar in fixed income:
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).
Capital Group (CG), the owner of American Funds, held a very rare meeting with the media, as reported by Bloomberg, Reuters and The Financial Times. What undoubtedly prompted the meeting:
The firm’s American Funds have lost $242 billion to withdrawals since the end of 2007, while Vanguard Group Inc., the largest index-fund provider, has attracted $607 billion, according to Morningstar Inc.
One way to counteract this shrinkage of AUM is to go on the offensive and promote an apparent dominance of active management over indexing. To that end:
Capital Group, based in Los Angeles, in a study released today, argued that its stock-picking mutual funds outperformed their benchmark indexes in the majority of almost 30,000 periods examined over the past 80 years. That included 57 percent of one-year stretches, 67 percent of 5-year periods and 83 percent of 20-year ranges.
The Capital Group study examined 17 of the company’s mutual funds that invest in equities or both equities and bonds. It measured their performance over every one-, three-, five-, 10-, 20- and 30-year period, on a rolling monthly basis, from Dec. 31, 1933, through Dec. 31, 2012.
Should investors care? Not really, because over such a long period of time, and especially in the last 15-20 years, the nature of investing has changed dramatically. There is more information available about both stocks and bonds, and this information is propagated with higher speed to a much broader investment audience, which makes markets more efficient and the job of an active manager more difficult. In addition, composite investment vehicles other than mutual funds — exchange-traded products (ETPs), tracking an ever-expanding spectrum of indices — have become readily available.
Finally, comparing just the returns of a mutual fund against those of its benchmark is largely meaningless because it does not fully adjust for the fund’s risk. Alpholio™’s methodology seeks to overcome this limitation by providing a dynamic, custom reference portfolio of ETPs for each analyzed mutual fund. Only the excess return of the fund over that of its reference portfolio, i.e. the RealAlpha™, counts.
According to the Bloomerg article:
Capital Group’s largest offering, the $123 billion Growth Fund of America, has seen its assets drop 31 percent in the five years ended Aug. 31. During that time the fund returned an annual average of 6.4 percent, compared with 7.3 percent for the S&P 500.
As an update to an earlier Alpholio™ post, here is how the risk-adjusted performance of this fund looked like since early 2005:
Despite a recent improvement, the fund’s performance in the last five years has been unimpressive. Small wonder many investors voted by withdrawing their assets.
A recent article in The Wall Street Journal attempts to compare the Vanguard Dividend Appreciation ETF (VIG) to iShares Select Dividend ETF (DVY) and other “peer dividend ETFs.” As is typical for such cursory analyses, the article lumps together ETFs with the word “dividend” in their name, and focuses on short-term (up to three years) returns to draw conclusions about the funds’ performance. The article only briefly touches on the difference of holdings of the two funds.
So, what are the proper ways to compare these funds? Here is one alternative comparison based on Sharpe Ratios (all figures calculated and published by Morningstar):
|Vanguard Dividend Appreciation
|iShares Select Dividend Index
|PowerShares FTSE RAFI US 1000
|WisdomTree LargeCap Dividend
|SPDR S&P Dividend
|iShares High Dividend Equity
In the longer 5-year period, which spanned a major market downturn, the Vanguard ETF exhibited a return/risk characteristic superior to that of the iShares ETF. However, the SPDR S&P Dividend ETF beat both according to that measure.
Another way to compare the first two of these ETFs is to use the dividend discount model to arrive at the expected rate of return. According to the article, the Vanguard ETF’s holdings currently yield about 2% in dividends and are expected to generate over 9% of earnings growth in the next three to five years. Assuming that the current dividend payout ratios and earnings growth rates stay approximately constant in the future, the ETF should return about 11% per year in total. For the iShares ETF, these figures are 7%, 4%, and also 11%, respectively. However, these identical results stem from vastly simplifying assumptions.
Finally, the two ETFs address different segments of the equity market. According to Morningstar, in the last three years the Vanguard ETF was most closely matched by the US Core Total Return index, while the iShares ETF’s best fit index was the Dow Jones Industrial Average Price Return index. This indicates that since the iShares ETF effectively tracked a much more narrowly focused index, it should not necessarily be compared to the more broadly-oriented Vanguard ETF. Indeed, Morningstar classifies the Vanguard ETF into the Large Blend category, while it puts the iShares ETF in the Mid-Cap Value category. Hence, the two ETFs are not really peers. Only the rest of the above dividend ETFs could be considered peers by virtue of the common, Large Value, category.