Swedroe: A Close Look At Neuberger Funds

In this installment of our continuing series on the ability of actively managed fund families to generate alpha, we'll evaluate the recent performance of equity funds managed by Neuberger Berman to determine if the firm adds value for its investors.

Regardless of whether it actually delivers on its promise, it seems Neuberger Berman's "active, risk-disciplined strategies" are attracting investors in droves. Morningstar reports that, as of May 31, 2015, the firm had $42.3 billion in assets, up from about the $26 billion it had at the end of 2011.

Background On Neuberger Berman

According to its website, Neuberger Berman has "been actively observing and investing in the global markets for over seven decades." The firm goes on to state:

"The strength of our investment culture derives in part from our emphasis on original thinking and fundamental research, complemented by our embrace of a diversity of investment strategies to help our clients achieve their unique investment objectives."

It then continues: "Our research is proprietary, conducted and disseminated for the exclusive use of our 42 portfolio management teams for the benefits of our clients. In 2013, we hosted over 1,800 meetings with companies in our offices alone … The firm remains relevant to our clients because we remain committed to finding opportunities both traditional and non-traditional in today's marketplace."

And finally: "Our experienced managers and our long-term outlook help define and motivate our approach and our decision-making … Managing risk is a central function in our culture at Neuberger Berman, famously articulated by our eponymous founder as the mission of 'preserving our clients' hard-earned capital.' The firm employs a rigorous, well-defined risk management framework staffed by dedicated, operational risk professionals, separate from our portfolio managers."

But are the funds managed by Neuberger Berman a better choice than passively managed alternatives?

Active Vs. Passive

As is our practice, we'll compare the performance of Neuberger Berman's actively managed funds to similar offerings in the same asset classes from two prominent providers of passively managed funds, Dimensional Fund Advisors (DFA) and Vanguard. (Full disclosure: My firm, Buckingham, recommends DFA funds in constructing client portfolios.)

To keep the comparison to a manageable number of funds, as well as to make sure we examine long-term results through full economic cycles, our analysis will cover the 15-year period from April 2000 through March 2015.

In addition, when more than one class of fund is available for the full period, we'll use the lowest-cost shares. In cases where Neuberger Berman has more than one fund in an asset class, we will use the average return of the applicable funds. The table below shows the performance of eight Neuberger Berman funds in six asset classes. 

April 2000 To March 2015

Following is a synopsis of the most important takeaways from the data in the table above:

• While the Neuberger Berman funds outperformed the DFA funds in two of the three asset classes in which comparable funds were available, a Neuberger Berman portfolio equal-weighted in those three asset classes returned 7.0 percent, underperforming a comparable portfolio from DFA, which returned 7.3 percent.
• In the two asset classes where Neuberger Berman funds outperformed, the average outperformance was 1.2 percentage points. In the asset class where the Neuberger Berman fund underperformed, the gap was 2.9 percentage points.
• This is consistent with the overall evidence on active management, which shows that when active funds do outperform, the outperformance tends to be relatively small. On the other hand, when they underperform, the gap tends to be greater.
• Also, the average expense ratio for the Neuberger Berman portfolio was 0.93 percent, versus just 0.24 percent for the DFA portfolio. Note that the underperformance of the Neuberger Berman portfolio was more than fully explained by the difference in average expense ratio (0.69 percentage points).

Including Vanguard In The Comparison

• In the six asset classes for which comparable Vanguard funds were available, an equal-weighted portfolio of Neuberger Berman funds returned 4.7 percent. The portfolio's average expense ratio was 0.98 percent.
• A Vanguard portfolio equal-weighted in those same six asset classes returned 6.1 percent, a full 1.4 percentage points more than the Neuberger Berman portfolio. In the two asset classes where Neuberger Berman funds outperformed, the average outperformance was 1.5 percentage points. In the four asset classes where Neuberger Berman funds underperformed, the gap was 2.7 percentage points.
• Once again, we see evidence that when active management outperforms, that outperformance tends to be smaller than the level of active management underperformance when it occurs.
• The average expense ratio for the Vanguard portfolio was 0.10 percent. In this case, the higher expenses of the Neuberger Berman funds explained more than 100 percent of the difference in returns.

Factor Analysis

We'll now take another look at the performance of Neuberger Berman funds using the analytical tools and data available at Portfolio Visualizer.

I've added two additional Neuberger Berman funds to this list. The reason they weren't included in the prior analysis is because there are no comparable funds from either Vanguard or DFA that were available for the full 15-year period.

The following table shows the results of the three-factor (beta, size and value), four-factor (adding momentum) and six-factor (adding quality and low beta) analysis for the firm's domestic funds. We'll cover the same 15-year period from April 2000 through March 2015. The t-statistics—or "t-stats"—are in parentheses. 

Negative Alpha?

When we examine the results from the three-factor analysis, we find that five of the 10 Neuberger Berman funds generated positive annual alphas. The average annual alpha was 0.0 percent. Only one fund's alpha was statistically significant at the 5 percent level, and its alpha was -2.9 percent.

When we look at results from the four-factor analysis, we also find that five of the 10 Neuberger Berman funds generated positive annual alphas. The average annual alpha was -0.3 percent. Two funds produced alphas that were statistically significant at the 5 percent level, and they were both negative.

When we include all six factors, we find that just three of the 10 funds generated positive alphas. The average alpha was -0.7 percent, which is slightly less than the average expense ratio of the Neuberger Berman funds. None of the alphas was statistically significant at the 5 percent level.

It's Worse Than It Looks

Before summarizing, there are two additional important points to consider.

• First, all of the data above is based on pretax results. For investors holding these funds in taxable accounts, the active management of Neuberger Berman almost certainly would have produced greater negative tax consequences than the passively managed alternatives of either DFA or Vanguard.
• Second, Morningstar data unfortunately contain survivorship bias. Thus, it's possible there were Neuberger Berman funds that had performed poorly in the past and were either merged into better-performing funds or closed. If that were the case, the data will overstate returns earned by the firm's investors.

While Neuberger Berman's website states that … "the firm remains relevant to our clients because we remain committed to finding opportunities both traditional and non-traditional in today's marketplace," … the analysis demonstrates that its efforts at finding opportunity have not translated into superior returns for investors.

In the cases comparing to both DFA and Vanguard funds, Neuberger Berman's funds were subtracting value. And that's even before considering the important issues of survivorship bias and, for taxable investors, taxes.

But letting alone those two important considerations, in terms of the factor analysis, there was no evidence that Neuberger Berman's fund managers were able to persistently exploit market inefficiencies.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.