A large body of literature examines whether managers of actively managed funds add value to their investors by generating abnormal returns. Unfortunately, not only do the vast majority fail to do so, but the evidence, as presented in my book, “The Incredible Shrinking Alpha,” demonstrates that the already-small percentage of managers able to beat their benchmarks has been diminishing at a rapid pace.
Indeed, 20 years ago, approximately 20 percent of active managers were adding statistically significant alpha on a pretax basis. Today that figure is down to about 2 percent.
Given that a large majority of investor dollars are still invested actively, either investors are unaware of the evidence, or choose—irrationally—to ignore it. Perhaps some investors ignore the evidence as a result of an all-too-human trait: overconfidence.
I suspect investors who suffer from overconfidence believe that (even though they acknowledge how difficult it is to outperform, and know even Warren Buffett warns that the vast majority of professionals fail at it) somehow they will succeed.
Another well-documented trait some investors possess is an irrational preference for dividends.
In their 1961 paper, “Dividend Policy, Growth, and the Valuation of Shares,” Merton Miller and Franco Modigliani famously established that dividend policy should be irrelevant to stock returns. This theorem has not been challenged since. Moreover, the evidence supports this theory, which is why to my knowledge there are no asset pricing factor models that include a dividend factor.
Unfortunately, it appears that the managers of mutual funds are well aware of the irrational preference some investors have for dividends, and they exploit that preference to the detriment of those same investors.
Lawrence Harris, Samuel Hartzmark and David Solomon—authors of the paper “Juicing the Dividend Yield: Mutual Funds and the Demand for Dividends,” which was published in the June 2015 issue of The Journal of Financial Economics—found that some mutual funds purchase stocks before dividend payments as a way to artificially increase their dividends.
In fact, more than 7 percent of the authors’ fund-year observations have dividend payments that are more than twice as large as their holdings imply. The authors called this behavior “juicing.”