Mutual fund return persistence, Part 1: Large Cap Value

There has been tons of research as to the existence of true skill among mutual fund managers. Often researchers will look at advanced statistics and in depth breakdowns of holdings. While this research is interesting, I think it is simpler than that…. Do mutual fund managers actually make me or you more money than owning an index ETF? To me, if a manager can add value over 5 or 10 years then they are skilled in my mind. This proves quite difficult for most managers.

To start, let us look at Large Cap Value. Using Morningstar’s categories, deleting out all funds with fewer than 10 years of performance, and removing all share classes except for the lowest fee class (in an attempt to give mutual funds the best shot at looking at least decent), I come to a database of 163 Large Cap Value funds. Their benchmark should be the Russell 1000 Value. I use IWD, an ETF that tracks the Russell 1000 Value, because let’s be honest, you other option aside from the mutual fund is not owning the index, it is owning the index ETF.

Below is a chart showing the percentage of funds outperforming the benchmark during 1, 3 and 5 year periods.


As you can see from the chart, consistently beating the benchmark is hard… really hard. As of the end of May, fewer than 40% of Large Cap Value funds are beating their index over the last 3 and 5 years, and keep in mind I am using the lowest fee class (investment minimums in these are often $1,000,000 plus).


Whats more, it is not only the act of out-performance that is rare, being able to do so consistently is even rarer. When we look at 3 year periods of performance, we find that funds doing well for one 3 year period will tend to do poorly over the next 3 years. Below is a chart looking at the best 20% of performers over the previous 3 years at each date listed on the right. The line represents the rolling 3 year active return over time. As you can see below, Alpha (return generated over benchmark) tends to bleed lower, going negative in almost all cases meaning that funds producing positive return over the benchmark in one period will tend to drift towards negative return in a future period.lcv2

What is the take away of this really brief look? Doing a good job in active management is really tough. Next post I will take out fees to show the deleterious effect fees have on the performance of these funds.

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