Long term mutual funds much worse than benchmark

[OverThinkMuch]

Sorry, not buying it. Financial advisors, out of self-interest, hold out the promise of beating an index. But consistently beating an index? Over, say, a five year period? This New York Times reporter did not find a single example out of 2,132 mutual funds examined.

I can't get through the paywall or see who wrote it, but most articles online are not written by someone with investment experience - they are not experts. The S&P 500 has returned in total +56% over the past 5 years according to etfdb's entry for SPY (S&P 500 ETF).
https://etfdb.com/etf/SPY/#performance

Here's their list of the top 100 ETFs over the past 5 years, ALL of which beat the S&P 500. I conclude they didn't do 5 minutes of research, or excluded ETFs for no good reason.
https://etfdb.com/compare/highest-5-year-returns/

 

[HawkOwl]

If any financial advisor is promising they can beat an index, they're not a very good FA. That's just not what FAs do.

Why would you pick a five year period? Why not 20 years? 40 years? Or 80 years? An actually usable time frame, not just a short snapshot in time? These funds exist. If you want pick a five year period, sure, every fund will lag over some five year period. And any given year? A total crapshoot. That's why it makes sense to generally ignore short term performance. Long term? That's a different story. You can either see the same funds outperform for a very long period of time managing money the way they say they will and say "They're executing the plan and it's working, that's why they're outperforming" or you can say "Eh, they've just been lucky for the last 20...40...80 years."

Only in money management do skeptics have the idea that this is impossible, despite it actually happening right in front of them.

Previously you stated:

‘ There are dozens of active funds I'm aware of that have beaten their benchmarks SINCE INCEPTION. Not just this year. Or during a specific, cherry-picked time period. FOREVER. Day one, start with the fund vs their index and the fund would have performed better. Period. For decades. ’

This led me to believe that you meant every year. I used a five year time horizon because it was generous to your position that your funds beat their index “since inception” and out of simplicity because it was the time frame used by the referenced authors.

In 2008, Warren Buffet offered a one million dollar bet with the hedge fund industry that a S&P 500 index fund would outperform a hand picked portfolio of ten hedge funds over a ten year period AFTER including fees, taxes on churning, costs and expenses. Only one manager took him up on this bet. Buffet won.

It is all about the expenses, as the author of this Investopedia chapter points out. Active management is expensive, and causes performance to lag. Advocates of actively managed funds don’t like to include this in their reports.

https://www.investopedia.com/articl...etts-bet-hedge-funds-year-eight-brka-brkb.asp

So, no, I don’t agree with your contention that “there are dozens of active funds I'm aware of that have beaten their benchmarks SINCE INCEPTION.” If you can reference studies that say otherwise, I would be willing and happy to read them.

 

[arcyallen]

Previously you stated:

‘ There are dozens of active funds I'm aware of that have beaten their benchmarks SINCE INCEPTION. Not just this year. Or during a specific, cherry-picked time period. FOREVER. Day one, start with the fund vs their index and the fund would have performed better. Period. For decades. ’

This led me to believe that you meant every year. I used a five year time horizon because it was generous to your position that your funds beat their index “since inception” and out of simplicity because it was the time frame used by the referenced authors.

In 2008, Warren Buffet offered a one million dollar bet with the hedge fund industry that a S&P 500 index fund would outperform a hand picked portfolio of ten hedge funds over a ten year period AFTER including fees, taxes on churning, costs and expenses. Only one manager took him up on this bet. Buffet won.

It is all about the expenses, as the author of this Investopedia chapter points out. Active management is expensive, and causes performance to lag. Advocates of actively managed funds don’t like to include this in their reports.

https://www.investopedia.com/articl...etts-bet-hedge-funds-year-eight-brka-brkb.asp

So, no, I don’t agree with your contention that “there are dozens of active funds I'm aware of that have beaten their benchmarks SINCE INCEPTION.” If you can reference studies that say otherwise, I would be willing and happy to read them.

First off, while I don't agree with some of your conclusions I appreciate your willingness to talk reasonably about this. Many aren't, which makes me sad. I like talking with people I don't think I agree with or don't understand. I think it's a great way to find better understanding of many things.

Like a five year number, "since inception" means the total performance between two dates: The date the fund opened, and today. Every minute, hour, day, week, and year are going to have ups and downs for each investment. In that five year span you mentioned, there were definitely funds that outperformed indexes for a day, week, or year. But the author (correctly) didn't discuss that, as the five year number is measuring the destination (the end of five years), not the journey.

To be clear, if you put a $1 into Fund A and $1 into Fund B, the five year number is going to tell you what those dollars were worth at the end of that five year period - not during it. The "performance since inception" number will tell you the same thing - what those dollars are worth at the end of that time period - not during it.

So, if we're on the same page - that those time frames are measuring the total result and not what happened throughout the time frames - then yes, I can easily find a dozen funds that have beaten their benchmarks since inception. I think working with the same facts is important - some people think many active funds outperform their indexes over long periods of time, and some people think that no active funds outperform their indexes over long periods of time. Both are wrong. I'm cool with different people being happy with indexes, or active funds, or whatever. No sweat. But I think starting with the agreeing on certain facts (and not opinions of those facts) is critical.

Do we agree?

 

[OverThinkMuch]

Another way to view the S&P 500 over 5 years: it has returned an average of 9%/year.

Kiplinger has a list of top performing mutual funds over 5 years, here are 3 that are in different categories (they have several "large growth" winners):

Shelton Green Alpha Fund (NEXTX) returned 15.6%/year
JPMorgan Large Cap Growth A (OLGAX) returned 15.2%/year
Calvert Social Investment Equity Portfolio A (CSIEX) returned 14.6%/year

You can also view the market by sectors of the economy, where the S&P 500 puts all those sectors together. It's impossible for every sector to trail the average. Information technology and health care decisively beat the S&P 500 over the past 5 years.

 

[Out-to-Lunch]

To me

‘ There are dozens of active funds I'm aware of that have beaten their benchmarks SINCE INCEPTION. Not just this year. Or during a specific, cherry-picked time period. FOREVER. Day one, start with the fund vs their index and the fund would have performed better. Period. For decades. ’

connotes something different than

The "performance since inception" number will tell you the same thing - what those dollars are worth at the end of that time period - not during it.

 

[arcyallen]

To me



connotes something different than

I agree, that might not be clear. Apologies.

 

[matjung]

How did you determine the bold statement above? Is it a feeling you have
or do you have inside information?
VW

I am (was) working in that industry and was studying monetary policy while at university.
It is now an observation, that all major countries stopped with negative interest rates.
The key idea was to encourage Banks to invest into loans and mortgages rather than depositing money at central banks.
Without evidence: Mission failed completely
(you can google yourself for studies in that field)
I guess we won't get negative nominal interest rates for a long time.

 

[Qs Laptop]

Trying to decide when/if to change mutual funds


Until pandemic, all active funds (IRAs) were pretty good - beating market benchmark. Last year, half of funds - way underperformed benchmark (20% worse than benchmarks)

Yes, just as your managed funds outperformed the market they will underperform the market in down times. Which is precisely the reason you don't want to switch to an index fund right now. The managed funds will likely outperform the market index on the upswing in the stock market, probably impressively outperform. Timing the market is virtually impossible but managed funds outperforming the index during the early-mid stages of a bull market is fairly predictable. I would advise to stay in managed funds at least for the beginning stages of the comeback. (Yes, it's hard to know when that is.) Then switch to index funds.

We have considered 3 options -

1 - change out underperforming to better performing active funds

Yes, if you are confident your changes will bear more fruit than your current picks. But how can you know that?

2 - change to index type funds (mutual or ETF) and accept market for long term

Not right now. Yes, after the market comes back quite a bit, I would consider this. Pick a percentage and make the change when you've reached that benchmark.

3 - wait 6 months and then decide if funds don’t start outperforming go to option 1 or 2 (or remain status quo - if outperforming again)

This isn't really a plan. Also, it sounds like you want to make a change. This choice wouldn't scratch that itch.

Given these should remain untouched for more than 10, maybe even 20 years - I am looking at these as long term.

You didn't say your age but I'm going to guess from your screen name that you are 52 years old. In that case I would incrementally transition into index funds as you get older.

When would you reconsider/select different mutual funds?

That depends on what funds you are holding right now. There are some mutual funds I likely will never get out of, though I might reduce my allocation to them.

 

[HawkOwl]

First off, while I don't agree with some of your conclusions I appreciate your willingness to talk reasonably about this……


…So, if we're on the same page - that those time frames are measuring the total result and not what happened throughout the time frames - then yes, I can easily find a dozen funds that have beaten their benchmarks since inception. I think working with the same facts is important - some people think many active funds outperform their indexes over long periods of time, and some people think that no active funds outperform their indexes over long periods of time. Both are wrong. I'm cool with different people being happy with indexes, or active funds, or whatever. No sweat. But I think starting with the agreeing on certain facts (and not opinions of those facts) is critical.

Do we agree?

Well, we seem to agree that civil discourse is preferable to acrimonious argument. That is always a good start.


There is a tendency for high flying funds to start out hot and then revert to the mean (or less). If you get in at inception, and if your fund has one of those rare explosive starts, and if you have discovered the next legendary manager before the rest of us do, and if it doesn’t do an ARK-like fizzle, it is possible that you could ride the early momentum to a somewhat better than it’s index results, at least for a period of time. But you see the problem with stipulating a string of many unlikely events in a row, don’t you?

Imo, the two greatest investment managers of all time are Peter Lynch and Warren Buffett. Fidelity Magellan had a tremendous run under Lynch, who got out before the (imo) inevitable reversion to the mean. Buffett never left Berkshire Hathaway, but in recent years it’s performance slightly lags the S&P 500 (Buffett himself famously said :”In my view, for most people, the best thing to do is owning the S&P500 index fund.”). So I will acknowledge that hitching your horses to the next Warren Buffett or Peter Lynch could give you oversized returns. The number of funds able to do this, small as they may be, are skewed upward by survivor bias. The funds that have a poor initial performance are often closed.

Yet how do you know which of thousands of very smart managers all trying to do the same thing are that rare needle in a haystack? By the time it is evident which one is a future legendary manager, they have lost their edge due to competitors mimicking their methods or by sheer growth into something so large that that it has no choice but to essentially be a S&P clone (but one with higher expenses). Some people trust their instincts and confidently latch onto one active fund or another. Of course some people trust their instincts and latch onto a single number on the roulette table too. Regrettably I don’t have a working crystal ball. Jack Bogle advised people not to seek the proverbial needle in a haystack, but rather buy the entire haystack. Sounds like good advice to me.

 

[arcyallen]

Well, we seem to agree that civil discourse is preferable to acrimonious argument. That is always a good start.

There is a tendency for high flying funds to start out hot and then revert to the mean (or less). If you get in at inception, and if your fund has one of those rare explosive starts, and if you have discovered the next legendary manager before the rest of us do, and if it doesn’t do an ARK-like fizzle, it is possible that you could ride the early momentum to a somewhat better than it’s index results, at least for a period of time. But you see the problem with stipulating a string of many unlikely events in a row, don’t you?

... So I will acknowledge that hitching your horses to the next Warren Buffett or Peter Lynch could give you oversized returns. The number of funds able to do this, small as they may be, are skewed upward by survivor bias. The funds that have a poor initial performance are often closed...

Yet how do you know which of thousands of very smart managers all trying to do the same thing are that rare needle in a haystack? By the time it is evident which one is a future legendary manager, they have lost their edge due to competitors mimicking their methods or by sheer growth into something so large that that it has no choice but to essentially be a S&P clone (but one with higher expenses). Some people trust their instincts and confidently latch onto one active fund or another. Of course some people trust their instincts and latch onto a single number on the roulette table too. Regrettably I don’t have a working crystal ball. Jack Bogle advised people not to seek the proverbial needle in a haystack, but rather buy the entire haystack. Sounds like good advice to me.

I think a big difference here is I think you're thinking of "hot" funds, and I'm thinking of older time-tested funds. Hot funds get the spotlight (oh ARK, haha!) but I have negative interest in those. My first screen for a fund is "has it been around for 10+ years", my second is "Is the management the same?". if it's a single manager. Magellan is a great example - the fund WAS Peter Lynch during his time. Now it IS someone else. Magellan in this case is just a name, the brains running it makes a much bigger difference. Third, I'd want them to have the same investment philosophy as me: Buy high quality investments (even when it's not popular), stay diversified (even when it's not popular) and hold for the long term. Few funds do this, but a few do. I've found that the few that do, do well. And the best of the best of those funds do great.

I'm an unabashed fan of American Funds. They do everything I mentioned above. After a lot of research they're they only fund company (who manages many funds) that do. They use a VERY tenured management team of 6-12+ managers for each fund. One benefit is if a manager leaves (which is rare for them) the fund doesn't crater. They also stick to the plan, even if they look bad temporarily doing so. They do great during down/flat times (contrary to what an earlier poster said about active funds in general), and they acknowledge that they lag during bull markets. And if it's the majority of their funds, going back many decades, I can't chalk it up to luck. They're doing something to make that happen.

Going back to the idea of "hot" funds, these aren't hot funds. But they are consistent as hell. Practically every one of their established equity funds beat their benchmarks since inception. That alone might make them the greatest fund company of all time in my book. As I said earlier, if the market is doing great (late 90s, the last ten years) they lag. But they more than make up for it when the market reverts. If it were just one or two of their funds, I'd be thinking "needle in a haystack" too. But if it's the majority of their funds.

I allow any fund I'm in to "make mistakes" but if they underperformed during an up market AND the following down market...that's when I'd be strongly reconsidering. Or if they broke any of those three rules above: Buy high quality, stay diversified, invest for the long term.

 

[LaDolceVita]

I don’t consider myself an expert, so what I have to say is purely anecdotal.

In the early 2000’s, I spent many, many hours studying mutual funds, proper asset allocation, fund manager performance, expense ratios, top ten holdings held in various funds, fund objectives, etc. etc. I reallocated my retirement savings with the highest-rated funds run by managers with the best track records, allocated between small, medium and large caps, allocated between growth and value. My risk tolerance is a bit lower than most, so I leaned towards mutual funds with a low-risk bias. The Perfect Portfolio for me, or so I thought.

During the downturn of 2009-2012, my portfolio experienced a GREATER loss than if I had just invested in low or no-fee index funds. The only reason I chose mutual funds in the first place was that I assumed that reputable, experienced fund managers would “know what to do” to mitigate damage during a downturn. In reality, the opposite is true…the size and duration of their positions in various investments prevents them from being appropriately nimble.

My investments eventually came back, but I no longer had enough faith to pay mutual fund managers to “keep me safe”. In 2013, I switched to nothing but index funds, ETFs, individual stocks and bonds, and real estate.

So…just use this anecdotal experience as another datapoint to help you with your investment decisions.

 

[Markola]

+1. Eventually, many (not all) mutual fund investors decide that it’s (much) more profitable over the long run to earn the market averages than to try to pick active funds, each with about 30 variables that need to go right in order for them to simply keep up with their respective market averages.

 

[matjung]

Trying to decide when/if to change mutual funds
Until pandemic, all active funds (IRAs) were pretty good - beating market benchmark. Last year, half of funds - way underperformed benchmark (20% worse than benchmarks)

Hi, I gave your writing a 2nd thought and discussed your posting on Friday with a local investment discussion club.
Maybe, your perception that the Fund under-performed too much is wrong.


We required more data to judge if the fund manager did well or not.
Are you able to break down the performance into quarters.
How did the fund and benchmark do in Q1, Q2, Q3 and Q4.
Is the sector composition of the fund and benchmark similar?
How many of the top 10 holdings of the fund are also highly weight in the benchmark.

 

[arcyallen]

We required more data to judge if the fund manager did well or not.
Are you able to break down the performance into quarters.
How did the fund and benchmark do in Q1, Q2, Q3 and Q4.

I'd love to know what your and the club's thought process would be regarding getting this information. I've never been in an investing club and it'd be interesting to see this!

 

[retire48in2018]

I was looking more at criteria as to when to change an actively managed mutual fund. I understand looking at quarterly performance reports, management changes, etc.

But, is there a quantitative approach as well? I don’t think it’s a good idea to change every quarter.

I do know of some who buy/sell their mutual funds every quarter selecting among the best each quarter. I’ve had a few FA try to convince me of that approach.

I could not get a way to simulate that - what would have happened last few years doing that ? It does not “feel” right to be buy/hold but changed the funds every quarter.

I adjust AA annually.

 

[arcyallen]

I was looking more at criteria as to when to change an actively managed mutual fund. I understand looking at quarterly performance reports, management changes, etc.

But, is there a quantitative approach as well? I don’t think it’s a good idea to change every quarter.

I do know of some who buy/sell their mutual funds every quarter selecting among the best each quarter. I’ve had a few FA try to convince me of that approach.

I could not get a way to simulate that - what would have happened last few years doing that ? It does not “feel” right to be buy/hold but changed the funds every quarter.

I adjust AA annually.

I guess that would depend a lot on what you personally think of investing. I personally can't imagine (or recommend) making changes because a fund underperformed for a quarter, year, or even five years. I would, however, make an immediate change if the management style moved away from what I wanted. For me, the only way I'm going to invest in stock based investments is over very long periods of time, Warren Buffet style. If that's not you, that's OK, but you'd need to figure out you.

What FAs are telling your to change every quarter? That is an absolute surefire way to underperform, and it's horrible and I think it's frankly unethical advice. Like, literally, who gave you that advice (if you can share)? How a fund did last quarter has zero bearing on how it'll do next quarter. If the world's greatest investors tell you they don't know what's happening next year, let alone next quarter, I wouldn't trust a fund manager...or an FA...to know either.

What is your thought process when you change your AA every year? What inputs go into making that decision?

Does this answer your question? Or are you looking for more hard and fast numbers based answers?

 

[Exchme]

OP seems unaware of the tricks of the active fund managers.

The easiest one is an inappropriate benchmark, comparing a higher risk active fund to a lower risk benchmark. So if the fund is high risk, just pick the S&P 500 as a benchmark and voila, outperformance on average.

Next trick - ignore tax inefficiencies of active management. While they can't know your tax situation, you should look before you decide if you are really getting value.

Next trick - Only look at the performance of the underlying fund and ignore the AUM fee taken off the top.

For really unscrupulous types - use the price of the comparison benchmark, ignoring dividends.

For ones giving you the soft soap about long term performance, cherry picking the start date is another golden ticket. Maybe they can show outperformance to the start of the fund, but maybe the last fund closed in failure and then this new one opened, papering over the fact that the strategy occasionally melts down.

Bottom line, Morningstar studies this every quarter and the findings are consistent. Over any 10-15 year period, only a few active managers really beat appropriate benchmarks by enough to cover their own fees and the ones that outperform change over time.

 

[arcyallen]

OP seems unaware of the tricks of the active fund managers.
...
Next trick - Only look at the performance of the underlying fund and ignore the AUM fee taken off the top.
...
For really unscrupulous types - use the price of the comparison benchmark, ignoring dividends.

While there may be plenty of legitimate concerns you may have regarding active funds, I think you're demonizing active fund companies for things they don't do or can't know.

Regarding the first one, you're confusing the payment of the people actually managing the fund money (that would be the internal expense ratio) with the payment the client makes to the FA holding the client's hand - a possible AUM fee. The fund company has zero idea how much any client is paying an FA, let alone all of them. Is it a number for the client and FA to take into consideration? Yes. The fund company? Impossible.

For the second one: Can you give just one example of this happening? Ever? If you do, that's great. I'm EAGER to hear about it. If not, this is just spreading misinformation.

 

[OverThinkMuch]

Bottom line, Morningstar studies this every quarter and the findings are consistent. Over any 10-15 year period, only a few active managers really beat appropriate benchmarks by enough to cover their own fees and the ones that outperform change over time.

S&P produces high quality SPIVA reports comparing active to passive investing. They track numerous biases like survivorship and style drift. Their 2021 report shows over 10 years, 86% of active mutual funds underperformed their benchmark.
https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2021.pdf#page=10

Unfortunately SPIVA tracks underperformance, not outperformance, so I can't cite what fraction of the other 14% tied vs beat their index. But we're talking about 165 surviving funds that either tied or beat their index. I find it very hard to believe only a single digit number beat their index.
https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2021.pdf#page=12

What is your source of the claim "only a few" beat the index over 10 years?

 

[HawkOwl]

S&P produces high quality SPIVA reports comparing active to passive investing. They track numerous biases like survivorship and style drift. Their 2021 report shows over 10 years, 86% of active mutual funds underperformed their benchmark.
https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2021.pdf#page=10

Unfortunately SPIVA tracks underperformance, not outperformance, so I can't cite what fraction of the other 14% tied or beat their index. But we're talking about 165 surviving funds that either tied or beat their index. I find it very hard to believe only a single digit number beat their index.
https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2021.pdf#page=12

What is your source of the claim "only a few" beat the index over 10 years?

Good article, but I am confused about this portion. If 86% of actively managed mutual funds fail to beat their index, doesn’t that REQUIRE that 14% tie or beat the index? Isn’t the answer 100%?

Anyway, good reference. I don’t have any trouble believing that only a single digit number or low double digits beat their index AFTER taking into account fees and survivor bias.

Here is a compilation of articles that casts doubt on the idea that an investor can predict which funds will be in that 14%.

https://www.bogleheads.org/wiki/US_mutual_fund_performance_studies

 

[OverThinkMuch]

HawkEye - poorly worded on my part, I've changed that to "tie vs beat" their index. I don't know if 0.1% or 13.9% beat the index out of the total 14.0%. If only 1/4th of the 14% beat, that would still be dozens of funds rather than the cliamed "few funds".

Also, if you're linking directly from the Active Investment forum to the Bogleheads forum, I think you might be in the wrong place. This isn't the place to champion passive investment.

 

[VanWinkle]

HawkEye - poorly worded on my part, I've changed that to "tie vs beat" their index. I don't know if 0.1% or 13.9% beat the index out of the total 14.0%. If only 1/4th of the 14% beat, that would still be dozens of funds rather than the cliamed "few funds".

Also, if you're linking directly from the Active Investment forum to the Bogleheads forum, I think you might be in the wrong place. This isn't the place to champion passive investment.

Those that are misinformed can always use some passive investment information to help them make an informed decision before placing their "bets" that an active manager is good instead of lucky. I believe in low cost active management for a portion of my investments. I do not believe in choosing hot funds each year hoping to score an early retirement.

VW

 

[Rianne]

In 2012 we set our portfolio AA 60/40, variety of stock index funds and bond funds (not managed). Left it there until April 2022 when we sold all bonds funds to laddered CDs and treasuries. Basically a safer hedge than bond funds. No withdrawal, only reinvesting dividends.

Our benchmark from 2012 to date 1/14/2023 has earned us 7.2% per year. How simple is that? The funds were basic VG funds. Mostly total stock market and S&P. IMO, it’s not worth the time to over analyze specific funds. A portfolio manager may move things around, buy and sell different funds chasing growth for a year or two? We listened to Bob Brinker years ago. Following his advice for low cost mutual funds. We’re there. Who wouldn’t grab 7%/year growth?

 

[VanWinkle]

In 2012 we set our portfolio AA 60/40, variety of stock index funds and bond funds (not managed). Left it there until April 2022 when we sold all bonds funds to laddered CDs and treasuries. Basically a safer hedge than bond funds. No withdrawal, only reinvesting dividends.

Our benchmark from 2012 to date 1/14/2023 has earned us 7.2% per year. How simple is that? The funds were basic VG funds. Mostly total stock market and S&P. IMO, it’s not worth the time to over analyze specific funds. A portfolio manager may move things around, buy and sell different funds chasing growth for a year or two? We listened to Bob Brinker years ago. Following his advice for low cost mutual funds. We’re there. Who wouldn’t grab 7%/year growth?

+1, well said.