Swedroe: Don’t Play The Loser’s Game

April 10, 2015


There are five categories in which we have comparable funds. To start, we'll equal-weight each of the AB funds in the same asset class. We'll then equal-weight the five asset classes. That produces a portfolio return of 5.7 percent for AB's actively managed funds.


Applying the same calculation to the portfolio of DFA funds produces a return of 6.7 percent. In addition, of the 10 AB funds we examined, just three (or 30 percent) managed to outperform the comparable DFA funds.


Thus, despite all the supposed advantages that AB professes to possess, there's no evidence to support Marx's claim that active management improves the odds of achieving your investment goals—at least not if you're using AB's funds.


I would also add it's possible that the results from the comparison could have been worse, because Morningstar's data contains survivorship bias. There could have been other AB funds that performed poorly during this period and as a result where either closed or merged out of existence. I don't have the tapes to know if that is the case.


Expenses Matter

Applying the same methodology that we used to calculate the AB funds' average return yields an average fund expense ratio of 1.26 percent. The DFA funds' average expense ratio is 0.27 percent. The 0.99 percentage point difference in expenses fully explains the 1 percent difference in returns between the two investment firms' funds. In other words, AB failed to add value not because of poor stock selection or market-timing skills, but simply because its expenses were higher.


In fact, because actively managed funds typically have higher turnover rates—which in turn result in higher trading costs—the gross returns of the AB funds (before accounting for any expenses) were probably higher than the gross returns of the DFA funds. This is fully consistent with the historical evidence showing that, in aggregate, actively managed mutual funds tend to have higher gross returns but lower net returns, the only type of returns investors get to spend.


As noted earlier, there's an overwhelming body of evidence demonstrating that, while it's possible to win the game of active management, using actively managed funds instead of passively managed funds greatly reduces your odds of achieving your financial goals. Making matters worse is that the percentage of active managers generating alpha (outperformance appropriate to risk-adjusted benchmarks) has been persistently shrinking.


My co-author Andrew Berkin and I present the evidence and explain why the quest for alpha has become increasingly frustrating for active managers in our recently published book, The Incredible Shrinking Alpha.

Larry Swedroe is the director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country.




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