Earlier studies of mutual fund managers have shown some evidence of skill, though not enough to outweigh costs. But because of other issues, like cost and trading, it is harder to get a sense of how good professional active investors actually are at stock picking.
So a new study by George Comer of Georgetown University and Javier Rodriguez of University of Puerto Rico is timely, though the news is not good. (here)
STARTING OUT AS YOU MEAN TO GO ON
Looking at 1,487 UITs which came into existence and matured between 2004 and 2013, the authors find the trusts displayed consistent negative alpha, or underperformance, despite the study cutting the data in numerous ways and using numerous benchmarks.
The UITs generated negative alpha of between -2.5 and -2.8 percentage points, with more than 65 percent of all UITs in negative territory. And all of this is despite the UITs having a modest 23-basis-point annual expense ratio. In other words, if active mutual funds are underperforming it is not simply because they create a drag on returns by trading too much. It should be noted that the UITs studied were not cheap products, carrying an average of more than 3 percent in upfront sales charges.
UITs started out by doing badly, and kept it up pretty much all the way until they were liquidated.
“We find that performance is negative and significant for the first quarter of the trusts’ life. Performance does improve over the remainder of the trust life, but it is still negative and significant,” the authors write.
Taking a broad view, the conclusion is hard to escape:
“Overall, these results suggest that the poor risk-adjusted performance of our UIT sample reflects poor stock selection skills by the trusts.”
The trusts studied also lagged similar mutual funds, so we can conclude that forcing full investment and limiting trading costs is not a sufficient advantage to start generating real outperformance.
Defenders of active fund managers will at this point be angrily insisting that UITs, because they don’t trade, are not a fair way to evaluate the entire active fund management industry. Trading in and out, running cash balances in order to nimbly take advantage of opportunities as they arise, all of these are part and parcel of how active funds try to compete.
True enough, but looking at UITs does give us a more pure window into stock selection skill.
Based on this study, and what we know from earlier ones of mutual fund managers, investors in actively managed strategies should not be hopeful that they will outperform, and less so that outperformance will happen because of superior stock selection skill.
That’s a big part of the puzzle, and the outlines are not looking hopeful for active management.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)
(Editing by James Dalgleish)
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