Most Popular ArticlesNovember 3, 2009
The Olympic high dive
Since we can’t forecast the performance of Putnam’s funds, let’s look first at how many mutual funds achieved the fund’s target benchmark over the three years ending September 30, 2009, during which the S&P 500 lost 5.49%:
Basis point margin above CPI |
100 |
300 |
500 |
700 |
Performance target |
2.54 |
4.54 |
6.54 |
8.54 |
# of funds beating margin |
1,669 |
974 |
345 |
124 |
% of funds beating margin |
28.7% |
16.5% |
5.8% |
2.1% |
These data were culled from Morningstar by Brigham Young University professor of finance Craig Israelsen. A note of caution: The numbers are skewed, because they do not take into account survivorship; many funds – notably poorly-performing ones – failed or were closed over this period. Thus, the percentages above overstate the likelihood of outperforming the benchmark.
A scant 2.1% of funds achieved the target set for the 700 fund, and almost all that did were positioned in high-performing, narrowly defined segments, such as China, Latin America, or Gold.
Morningstar assigns the 500 and 700 funds to its World Allocation Fund category. Within that category, 3 of 35 (8.6%) funds returned 8.54% or greater over three years ending 9/30/09, with an average return of 0.24%. Morningstar, however, assigns many total return-oriented funds to its Long-Short, Moderate Allocation, and World Bond funds. Across all four fund categories, 17 of 388 (5.0%) funds returned 8.54% or greater, and those funds on average lost 0.50% over the last three years.
We can also turn to Ron Surz’ PODS universe to assess the likelihood of Putnam hitting its benchmarks. Surz simulated all possible US large cap portfolios, assuming a “market-neutral” strategy that could go long or short any individual holding. Over the three-year period, a fund returning 8.54% would be among the top 2% or 3% of possible funds. Surz’ analysis does not include leverage or asset classes other than equities, but it confirms that an exceptionally high degree of skill is required to beat inflation by 700 basis points if one’s universe is restricted to US equities.
The data looks slightly better among hedge funds. According to Chicago-based Hedge Fund Research, Inc., the percentage of funds outperforming the above benchmarks over the three years ending 9/30/09 were 65.5%, 56.6%, 45.8% and 37.0%.
Survivorship bias, however, plays an even greater role in the hedge fund industry, which has contracted significantly over the last several years. The probability of any given hedge fund outperforming the benchmarks above is significantly lower than these figures suggest. Hedge funds also have a significant advantage over mutual funds like Putnam’s for a number of reasons, including the fact that they are not subject to daily redemptions.
Given the recent extreme bear market, Knight said that this three-year period is not necessarily the appropriate time period for evaluation, and that his shareholders would have been extremely happy with his results had his fund been operating over the entire interval. Nonetheless, it is precisely during difficult periods – including extreme bear markets – that these strategies must demonstrate their value; it is far easier to achieve a fund’s benchmarks during a bull market.
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