John West and Ryan Larson respond:
Thank you, Mr. Schwarzberg, for your response to our recent Fundamentals piece on peer groups. We think you hit the nail on the head!
In addition to the points you highlight with respect to relative performance, we think most investors are unaware of the magnitude of manager attrition (bad manager attrition) during the market crisis of 2008. Because peer groups show average fund and manager returns, we suspect average investor returns aren’t nearly as rosy.
Your research on the mutual fund universes tells essentially the same story as our research—the average mutual fund just barely beat the S&P 500 for the 2000s. Our universe did a little bit better than yours, but the moral of the story is exactly the same…after adjusting for survivorship bias and taxes, the average mutual fund during the decade did worse than the S&P!
|
1 year |
3 year |
5 year |
10 year |
Schwarzberg Mutual Fund |
28.08 |
-5.13 |
0.47 |
-0.86 |
RALLC-cited Mutual Fund Universe* |
26.76 |
-5.15 |
0.55 |
-0.43 |
S&P 500 Index |
26.46 |
-5.63 |
0.42 |
-0.95 |
*Source: Lipper
Similarly, your results for separately managed accounts are consistent with our results. Our universe does not include index or enhanced index strategies, which could explain our higher returns than your SMA universe for the longer time periods. The end result is the same for both of our universes: the average manager (in the universe) outperforms the S&P 500 by about 2-2.5 percentage points over the 10-year period.
|
1 year |
3 year |
5 year |
10 year |
Schwarzberg SMA |
28.51 |
-4.60 |
1.18 |
1.12 |
RALLC-cited SMA Universe* |
26.49 |
-3.77 |
1.91 |
1.48 |
S&P 500 Index |
26.46 |
-5.63 |
0.42 |
-0.95 |
*Source: eVestment Alliance
But, there is more to the story…a peer group of surviving funds is not representative of what the average investor really experienced. Controlling for survivorship and backfill biases, and fees, the results are more like a wash.
We agree with your point that some active managers will always be able to provide higher returns than their corresponding indexes. We also believe it is a very difficult task for the average investor to find and select that small group of outperforming managers ex ante (before hand). Case in point was the 2000s – a decade where the average active manager had a nice tailwind, witness the returns of the Fundamental Index or even equal-weighted indexes. Yet, the average active mutual fund still lagged the S&P 500, while the average active separate account manager (after adjustments) was negligibly better! This is not awe-inspiring performance.
In closing, we applaud efforts by advisors such as yourself who are attempting to find a better representation of the average fund or separate account strategy. The active/passive debate is hard enough to settle with accurate data, let alone the Global Financial Crisis induced mirage that is today’s peer groups.
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