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SAFT ON WEALTH-Institutions beat individuals on the active investment fool's errand: James Saft – Nasdaq

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Reuters


(James Saft is a Reuters columnist. The opinions expressed are
his own)
    By James SaftAug 9 (Reuters) - Institutions do better than individuals at
active fund management, but given that both come out losers the
underlying message is that picking stocks and bonds is a game
neither group should play.
    The vast majority of all mutual fund and institutional
accounts failed to keep pace with their benchmarks over the past
decade, according to a new report from S&P Dow Jones Indices
examining the impact of fees. (https://us.spindices.com/documents/research/research-spiva-institutional-scorecard-how-much-do-fees-affect-the-active-versus-passive-debate.pdf)
    And while institutional accounts, owned by large and
deep-pocketed investors with formal selection processes, usually
performed better than their mutual fund peers, the difference is
almost always not because their managers are better. Instead,
institutions are better at negotiating lower fees.
    In other words, and we've learned this before, active fund
management is a fool's errand. Institutional accounts did
better, but it was all a little like the old joke in which the
man frequents a restaurant because "the food is terrible, but
the portions are large."
    Unless you are an active mutual fund investor, in which case
your terrible food is a bit more expensive.
    The report examined the impact of fees on mutual fund and
institutional account performance over the past decade, using
data from the University of Chicago and eVestment Alliance.
    "Across various categories within the domestic equity space,
the overwhelming majority of active managers, both retail and
institutional, lagged their respective benchmarks," according to
the report.
    "Overall findings suggest that on a gross- or net-of-fees
basis, the U.S. equity space poses meaningful challenges for
active managers to overcome."
    "Meaningful challenge" is somewhere between kind and a
massive understatement.
    Among large-cap equity mandates benchmarked to the S&P 500,
84.60 percent of mutual funds underperformed the market over 10
years after fees are deducted, as well as 79.58 percent of
institutional accounts. Looking at the same category gross of
fees mutual funds bested institutions slightly, in that only
68.16 percent of them failed to match market return over 10
years, as compared to 69.20 percent of institutional accounts.
    This illustrates both that institutions are better
positioned to drive a hard bargain, but for a service which is
effectively giving them what they deserve good and hard.
    Wait, I can almost hear the active managers say, "you are
cherry-picking data".
    "If only," I can only ruefully reply.

    BUTCHER'S BILL
    Net of fees 95 percent of large-cap growth mutual funds and
90 percent of institutional accounts lagged. The same statistics
for mid-cap core funds were 98 and 95 percent, respectively. My
sense of fairness impels me to tell you that in only one of the
17 categories of domestic equities did active mutual funds
outperform, and that is large-cap value funds, where only 47
percent failed to keep pace with their benchmark, gross of fees.
Take fees into account, of course, and that number grows to 64
percent.
    There was not a single domestic equity category over the
past 10 years in which investors would have been better off
holding the typical mutual fund or institutional account.
    Not one.
    But wait, our active manager friend chimes in, "domestic
equity is a commodity, look at international and emerging
markets, that's where we add value."
    OK, let's.
    International small-cap equity is as close as it gets, but
here too, while 48 and 50 percent of mutual and institutional
accounts beat their benchmark over a decade, this is only gross
of fees. More than 60 percent in both cases underperform when
fees are counted. As for emerging markets funds, 86 percent of
mutual funds don't match the index over our 10 years, nor do 79
percent of institutional accounts.
    In fixed income, comparisons between mutual funds and
institutional accounts can't be made as easily on an
apples-to-apples basis, but the overall message is the same.
While many more fixed income managers beat their index on a
gross basis, the majority still do not when you take into
account fees.
    For example, a creditable 48 percent of emerging market debt
mutual funds lag their benchmark before fees, but that rises to
a regrettable 76 percent after fees. The best the industry can
do in fixed income mutual funds is in investment-grade
intermediate funds, where only 59 percent lag. Not much of an
advertisement.
    Institutions paid a good bit less in fees for their fixed
income active management but also got the same market-lagging
performance.
    While passive investing may possibly be, as Sanford
Bernstein analysts put it recently "worse than Marxism," active
management, as shown in the S&P report, is socialism for fund
managers.

 (Editing by James Dalgleish)
 ((jamessaft@jamessaft.com))

(((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 http://blogs.reuters.com/james-saft)))

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