Stockpicker’s Delight
active management, active share, analysis, correlation, mutual fund

A recent piece in Barron’s proposes an investment into seven actively-managed mutual funds. This recommendation is motivated by the following observation:

A long, humiliating period for professional stockpickers might be giving way to something different. Stocks that have moved in near unison in recent years are beginning to chart more distinct paths. Data points that haven’t mattered in a decade, like the relationship between prices and fundamental measures of value, are starting to have more sway on returns. The divide between cheap stocks and expensive ones remains exceptionally wide, which could mean last year’s shift in favor of value investing is just the beginning.

Supposedly, were on the verge of entering the “stockpicker’s market,” as shown in this chart:

Average Pair-Wise Correlation of All S&P Stock Combinations

The myth that low correlations between stock returns lead to active manager’s outperformance has long been debunked. Similarly, a high active share is cited as one of the reasons actively-managed funds will outperform their passive peers. Please refer to our earlier post for a discussion of this topic.

So, this post will instead focus on the long-term performance of the funds featured in the article:

Time for Proactive Investing

The following charts with related statistics show the cumulative RealAlpha™ for each fund that has at least ten years of history through 2016 (to learn more about this and other patent-based performance measures Alpholio™ uses, please consult our FAQ). In all analyses, the number of ETFs in the reference portfolio was limited to no more than seven. The ETF membership and weights in each reference portfolio were constant throughout the entire evaluation period.

Here is a chart with statistics for the AllianzGI NFJ Dividend Value Fund (PNEAX; Class A shares):

Cumulative RealAlpha™ for AllianzGI NFJ Dividend Value Fund (PNEAX) over 10 Years

The fund cumulatively returned over 20.5% less than its reference ETF portfolio of lower volatility.

Here is a chart with statistics for the DFA US Large Cap Value Portfolio (DFLVX; Class I shares):

Cumulative RealAlpha™ for DFA US Large Cap Value Portfolio (DFLVX) over 10 Years

The fund cumulatively returned about 8.5% more than its reference ETF portfolio of lower volatility.

Here is a chart for the Dodge & Cox Stock Fund (DODGX):

Cumulative RealAlpha™ for Dodge & Cox Stock Fund (DODGX) over 10 Years

While the fund produced a 14% higher cumulative return than its reference ETF portfolio, by early 2016 it also lost virtually all of its cumulative RealAlpha™ generated since 2007.

The following chart is for the Sound Shore Fund (SSHFX):

Cumulative RealAlpha™ for Sound Shore Fund (SSHFX) over 10 Years

On a cumulative return basis, the fund underperformed its reference ETF portfolio by over 7.7%; most of that loss occurred over the past two years.

This chart is for the T. Rowe Price Equity Income Fund (PRFDX):

Cumulative RealAlpha™ for T. Rowe Price Equity Income Fund (PRFDX) over 10 Years

The fund’s cumulative return was over 23.3% lower than that of its reference ETF portfolio of a slightly higher volatility.

The final chart is for the Vanguard U.S. Value Fund (VUVLX; Investor Class shares):

Cumulative RealAlpha™ for Vanguard U.S. Value Fund (VUVLX) over 10 Years

The fund cumulatively returned about 9.1% more than its reference ETF portfolio of a slightly lower volatility. However, as recently as at the end of October 2016, the cumulative RealAlpha™ was only 4.4%.

In conclusion, only three out of the six funds analyzed above added some value when compared to their respective reference ETF portfolios. The rest of the funds underperformed, and in some cases quite significantly. It remains to be seen whether a combination of the expected low stock correlations in the market and a high active share of these funds leads to their significant outperformance in 2017.

To learn more about these and other mutual funds, incl. the composition of their reference ETF portfolios, please register on our website.

To learn more about the these and other mutual funds, including the composition of their reference ETF portfolios, please register on our website.


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Analysis of Dodge&Cox Stock Fund
analysis, mutual fund

A recent story in Barron’s profiles the Dodge & Cox mutual fund firm, and in particular, its Dodge & Cox Stock Fund (DODGX). This $60.3 billion no-load fund sports a low 0.52% expense ratio and 17% turnover. According to the article

Three of its funds have a 15-year track record, each of which has outdone its benchmark over that period, the best relative performance of any large firm. The $60 billion Dodge & Cox Stock fund (DODGX), for example, has posted average annual returns of 8.7% over the past 15 years, twice that of the Standard & Poor’s 500.

In addition, the fund’s calendar year performance has been equally impressive:

Dodge & Cox Stock - Outperformance Over the Years

The prospectus benchmark for the fund is the S&P 500® index. Instead of using an artificial calendar year boundary for a periodical comparison of the fund with an inaccessible index, it is better to compare rolling returns of the fund with those of a practical implementation of the index. After all, many investors do not start their investments in the fund precisely on the last trading day in December, and they also consider an index mutual fund or an ETF as an investment alternative.

In the case of Dodge & Cox Stock fund, let’s use the SPDR® S&P 500® ETF (SPY) as such an alternative. Alpholio™ analysis shows that since early 2000, the fund returned more than the ETF in about 68% of all rolling 12-month periods and in only 58% of all rolling 36-month periods. With 60-month (five-year) rolling periods, this statistic further decreases to approximately 51%, with median outperformance of just 1.9% per period.

However, as Alpholio™ showed in a previous post, this does not paint a complete picture of the fund. In particular, with a single static index as a benchmark, there is no adjustment for the fund’s risk.

In the simplest application of its patented methodology, as an alternative to the analyzed fund Alpholio™ constructs an ETF portfolio with static membership and weights. This analysis shows the since 2004, the fund generated only about 0.5% of annualized discounted cumulative RealAlpha™ (to learn more about RealAlpha™, please visit our FAQ). The fund’s top three equivalent positions were in the Health Care Select Sector SPDR® Fund (XLV; average weight of 14.5%), Financial Select Sector SPDR® Fund (XLF; 14.3%) and Consumer Discretionary Select Sector SPDR® Fund (XLY; 12.1%).

In a more elaborate approach, Alpholio™ constructs a reference ETF portfolio with fixed membership but fluctuating weights. This allows for a more accurate matching of the analyzed fund’s returns over time. The following chart presents the resulting cumulative RealAlpha™ for the Dodge & Cox Stock fund:

Cumulative RealAlpha™ for Dodge & Cox Stock Fund (DODGX)

Since late 2004, the fund generated a slightly negative annualized discounted cumulative RealAlpha™. The fund underperformed relative to its reference portfolio from mid-2007 through mid-2012. The fund’s volatility, measured as a 17.1% annualized standard deviation of monthly returns, was about 0.6% higher than that of the reference ETF portfolio. The fund’s RealBeta™ was about 1.05.

The following chart illustrates changes of ETF weights in the reference portfolio over the same analysis period:

Reference Weights for Dodge & Cox Stock Fund (DODGX)

The fund had top equivalent positions in the iShares S&P 100 ETF (OEF; average weight of 23.4%), Vanguard Financials ETF (VFH; 12.7%), iShares Global Healthcare ETF (IXJ; 11.9%), Guggenheim S&P 500® Equal Weight ETF (RSP; 11.5%), Vanguard Consumer Discretionary ETF (VCR; 9.1%), and Vanguard Industrials ETF (VIS; 6.2%). The Other category in the chart collectively represents six additional equity ETFs with smaller average weights.

As a result of its prolonged underperformance with respect to a dynamic reference ETF portfolio of comparable risk, since late 2004 the Dodge & Cox Stock fund failed to produce a positive RealAlpha™. Even if a static ETF portfolio was used as a reference, the fund added most of the value in a short period after April 2012. While the fund’s modest expense ratio and small distributions may make it an attractive holding even in taxable account, investors should carefully consider alternatives.

To learn more about the Dodge & Cox Stock and other mutual funds, please register on our website.


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Analysis of Dodge&Cox Stock Fund
analysis, mutual fund

Dodge & Cox Stock (ticker symbol DODGX) is a mutual fund with approx. $42.9 billion in total net assets managed by John Gunn and associates. Currently, Morningstar rates the fund Three Stars / Gold in the US OE Large Value category. The latest Morningstar report on the fund, titled “Shareholders need to share management’s patience” was published in October 2012. At present, this no-load fund has a total expense ratio of 0.52% and sports a low 11% portfolio turnover rate. Let’s evaluate the fund’s performance using the Alpholio™ methodology.

First, the total return chart, which assumes reinvestment of all distributions into the fund and each member of the reference portfolio, respectively:

Cumulative Return of DODGX and Reference Portfolio

The chart demonstrates that from early 2005 to late 2007, the performance of the fund was generally matched by that of its reference portfolio. Subsequently, the fund underperformed.

This is further illustrated by the cumulative RealAlpha™ chart:

Cumulative RealAlpha™ for DODGX

In the chart, the lag cumulative RealAlpha™ curve overlaps, for the most part, the regular RealAlpha™ curve from 2005 through 2008. Typically, this is an indication that the fund managers did not make any major directional bets that significantly departed from the fund’s holdings in the immediately preceding time window. From 2009 onwards, this approach changed; however, the net result was an undesirable downward trend of the cumulative RealAlpha™. In addition, in that period the lag RealAlpha™ curve was below the regular RealAlpha™ curve, which implies that some of the managers’ bets backfired – the investor would be better off sticking with the frozen reference portfolio (see FAQ).

The overall statistics further underscore the unimpressive performance of the fund, esp. in the latter part of the analysis period:

DODGX Statistics

At about 18.5%, the fund’s volatility, measured by an annualized standard deviation of monthly returns in the entire analysis period, was slightly higher than that of the overall stock market. The volatility of the reference portfolio was slightly lower than that of the fund. This typically indicates that the fund was well diversified and contained positions generally present in the reference exchange-traded products (ETPs). The discounted annualized RealAlpha™ of the fund was approx. negative 1%, which was mostly caused by a significant loss of alpha since 2008. At about 1.05, the fund’s RealBeta™ was slightly higher than that of the market, which was also reflected in the elevated volatility.

The following chart demonstrates the use of smoothed RealAlpha™ to automatically generate a hypothetical trading signal for the fund:

Buy-Sell Signal for DODGX (Smooth)

The analysis starts with an assumption that the investor initially bought the fund in early 2005 and intended to hold this investment indefinitely, i.e. at least through early 2013. The blue curve depicts the cumulative RealAlpha™ in that entire period. Since there is some degree of high-frequency oscillation in that curve, its longer-term trend can be elicited from its smoothed approximation, depicted by the green curve. Subsequently, a simple decision criterion is applied to determine whether the investment in the fund should be retained. As long as the fund generates positive monthly increments to cumulative RealAlpha™, the investment in the fund is considered beneficial. Conversely, if the fund’s cumulative RealAlpha™ begins to consistently decrease, the investment is no longer considered attractive.

The signal would allow an investor to avoid the two long periods of the fund’s underperformance according to the smoothed RealAlpha™ measure. Please note that there is not guarantee that the recent positive trend in cumulative RealAlpha™ will continue to sustain a buy signal.

The following chart shows the major investment “themes” of the fund over time:

Reference Weights for DODGX

In the analysis period, the fund held equivalent equity positions in OEF (iShares S&P 100 ETF; average weight of 20%), RSP (Guggenheim S&P 500® Equal Weight ETF; 14.2%), VFH (Vanguard Financials ETF; 11.6%), VCR (Vanguard Consumer Discretionary ETF; 10.3%), IXJ (iShares Global Healthcare ETF; 9.9%), and VHT (Vanguard Health Care ETF; 7.3%).

For clarity, smaller reference positions are collectively represented by the Other category in the chart. For example, this category includes an equivalent position in VDE (Vanguard Energy ETF; average weight of 5.7%).

Unlike others, this mutual fund did not exhibit an equivalent cash position in the analysis period. This indicates that the fund generally avoided building substantial cash reserves in an effort to time the market, and instead continuously favored equity holdings. This is what most investors in the fund would certainly appreciate.

While the Morningstar analyst report says that

“Persistence pays off for Dodge & Cox Stock.”

this analysis clearly demonstrates that the strategy of the fund could easily be replicated using a fairly small number of exchange-traded products (ETPs), and with a better performance (higher return with lower volatility). Investors could use the results of the ongoing Alpholio™ analysis to construct a dynamic substitute portfolio of liquid, low-cost instruments that provide a better diversification than the fund does (75 stocks at the latest regulatory filing).


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