Today’s profile in Barron’s features the TIAA-CREF Bond Fund (TIORX; Retail Class shares). This $3.5 billion no-load fund has a 0.62% expense ratio and an elevated 309% turnover. According to the article
[active management] has guided [this] low-cost fund to 4.5% average annual returns over the past three years—better than 85% of intermediate-bond funds tracked by Morningstar and ahead of the 4.2% average annual gains for the Barclays U.S. Aggregate Bond Index.
The current lead manager took the reins of the fund in late August 2011. Therefore, this analysis will span from September 2011 through June 2016.
The primary prospectus benchmark for the fund is the Barclays U.S. Aggregate Bond Index. One of the accessible implementations of this index is the iShares Core U.S. Aggregate Bond ETF (AGG). Alpholio™’s calculations show that in the above time frame the fund returned more than the ETF in approximately 91% of all rolling 36-month periods, 80% of 24-month periods and 68% of 12-month periods. The fund’s median cumulative (not annualized) outperformance over a rolling 36-month period was 2.1%.
A comparison of rolling returns tries to approximate the average holding period of the fund. However, it does not take the fund’s composition and volatility into account. To adjust for the latter, let’s apply the simplest variant of Alpholio™’s patented methodology. In this approach, a reference ETF portfolio with both fixed membership and weights is custom-built to most closely track returns of the analyzed fund. Here is the resulting chart and related statistics of cumulative RealAlpha™ for the TIAA-CREF Bond Fund:
Over the entire analysis period, the fund added virtually no RealAlpha™. At 2.88%, the fund’s standard deviation (a measure of volatility of returns) was 0.08% higher than that of the reference portfolio. The fund’s RealBeta™ was close to zero, which implies very little correlation of the fund’s returns to those of the broad-market equity ETF.
The following chart and accompanying statistics illustrate the constant reference ETF portfolio for the fund:
The fund had major equivalent positions in the Vanguard Mortgage-Backed Securities ETF (VMBS), SPDR® Barclays Intermediate Term Corporate Bond ETF (ITR), iShares Intermediate Credit Bond ETF (CIU), Vanguard Intermediate-Term Corporate Bond ETF (VCIT), Schwab U.S. Aggregate Bond ETF™ (SCHZ), and PIMCO 0-5 Year High Yield Corporate Bond Index ETF (HYS). The Other component in the chart collectively represents additional six ETFs with smaller weights. (Some of the weights in the above table are shown as zero due to rounding.)
Under current management, the TIAA-CREF Bond Fund added practically no value on a truly risk-adjusted basis. An investor could have achieved similar results with a simple reference ETF portfolio comprising just six to nine fixed positions. The article provides a likely explanation
…[the lead manager] is quick to give credit to the 13 managers who run individual “sleeves” of the portfolio.
It appears that all the intense trading of the fund’s holdings (re: turnover in excess of 300%) merely compensated for its substantial management expenses.
To learn more about the TIAA-CREF Bond and other mutual funds, please register on our website.
With the new Fund Manager of the Year awards from Morningstar, a question of future performance of star fund managers inevitably arises. Apparently, the awards carry little short-term predictive value:
While our Fund Manager of the Year awards are recognition of past contributions rather than predictions of future results, we’re confident in each one’s long-term prospects because of their deep research resources and willingness to stick with their discipline in good times and bad. We wouldn’t expect repeat performances in 2014, as our winners and their rivals will wrestle with lofty equity valuations, policy-related volatility, a still-recovering economy, and the specter of rising rates.
Indeed, statistics on award winners presented by an article in The Wall Street Journal are not too encouraging:
||Beating the Benchmark
Generally, the best long-term predictors of fund outperformance remain a low expense ratio (fees), minimal portfolio turnover (a proxy for trading costs), and divergence from benchmark index weightings. The latter measure, known as active share should be high:
Prof. Cremers says the best funds tend to have active-shares percentages that are at least 60%. Large-stock managers should ideally have an active share above 70%. Midcap managers should have active share above 85% and small-cap managers should exceed 90%, he says.
Unfortunately, the proportion of funds with such big active shares has been falling over the years, which gave rise to “closet indexing,” as a chart from a Lazard Research study demonstrates:
The active share in the aggregate portfolio of actively-managed U.S. stock funds has been also declining:
However, active is not always a guarantee of strong performance, as shown in an earlier Alpholio™ post.
As for fund fees, an article in The New York Times points out that
The average total expense ratio, which encompasses management fees and operating expenses but not brokerage commissions and other trading costs, is 1.33 percent of assets a year for domestic stock funds and 0.97 percent for domestic bond funds, according to Morningstar.
Over time, these fees add up. According to a paper by William Sharpe, which estimated an average expense ratio of stock funds at 1.12% compared to 0.06% (now 0.05%) for the Vanguard Total Stock Market Index Fund (VTSAX, Admiral Shares):
Whether one is investing a lump-sum amount or a series of periodic amounts, the arithmetic of investment expenses is compelling… Under plausible conditions, a person saving for retirement who chooses low-cost investments could have a standard of living throughout retirement more than 20% higher than that of a comparable investor in high-cost investments.
However, as a Gerstein Fisher study found, the cheapest funds may not always provide the highest returns:
We found that the best performing quintile of funds was the second most expensive quintile (i.e., the 21-40% highest-cost ones), whether we equally weighted funds or asset-weighted them. The consistent results of the study: the cheapest quintile of funds was not the best performing, but the most expensive funds were the worst performing.
Similarly to a low correlation, a factor that is often quoted to aid stock pickers is a high degree of dispersion (measure of spreading) of stock returns. At first blush, it would seem that, just as with active share, an increased dispersion is beneficial. However, all it does is to enlarge the dispersion of active fund returns, without necessarily moving the average, as another article in The Wall Street Journal indicates:
A bigger spread between the best and worst stocks hasn’t helped active funds as a group, but it does tend to make good funds better—and bad funds worse… To put it another way: Markets that aren’t moving in lock step give active managers more rope with which to climb above the pack or to hang themselves.
While a low cost and small turnover coupled with a significant active share are generally good screening criteria, funds clearly have trouble with performance persistence. As our analyses have repeatedly demonstrated, even the star fund managers stumble, so outperformance is fleeting. This is where the Alpholio™ methodology helps by showing momentum in the smoothed cumulative RealAlpha™ for each analyzed fund, from which buy/sell signals can be derived. To learn more, please visit our FAQ.