BOSTON Jan 28 U.S. investors have all but tuned
out the boldest and best mutual fund stock pickers, leaving
billions of dollars on the table for each of the past five
Stung by the 2008 financial crisis, mutual fund investors
have plunged into low-cost, low-risk passive investments such as
index funds, happy to take whatever the market gives them
instead of reaching for excess returns.
But the opportunity cost has been enormous.
An easy way to look at it is to compare rival mutual fund
titans Vanguard Group, the reigning champion of the index fund,
and Fidelity Investments, whose actively managed portfolios have
outperformed benchmarks for the past five years.
Vanguard received $75 billion in net flows in 2013 - more
than three times any other firm - while Fidelity had only $5
billion in net flows, lagging about half of the 35 largest fund
families, according to Morningstar Inc.
"The Vanguard tsunami leaves all of us a smaller player,"
said Art Steinmetz, who oversees $232 billion in assets as
president of OppenheimerFunds. "You can't do it more cheaply
than Vanguard with their scale... Year in and year out, they
have every day low prices and they don't have to apologize for
performance," he said.
The price tag for playing it safe becomes clearer when you
drill deeper into the numbers: The average actively managed
stock fund at Fidelity has outperformed its benchmark by 1.33
percentage points, net of fees, each year since 2008. That has
resulted in $35 billion worth of added value, or outperformance,
for Fidelity's investors, said Brian Hogan, president of
Fidelity's Equity Group who oversees $750 billion worth of
actively managed stock funds.
Hogan holds up Joel Tillinghast, portfolio manager of the
$48 billion Fidelity Low-Priced Stock Fund, as one of
Fidelity's ultimate active stock pickers. Over the past 24
years, Tillinghast has outperformed his benchmark by 5
percentage points a year after fees.
But investors are not stampeding into Tillinghast's fund to
access his returns. In fact, over the past five years, investors
have pulled nearly $3 billion from the fund in outflows,
according to Lipper Inc, a Thomson Reuters company.
Christopher Philips, a senior investment analyst at
Vanguard, said a lot of money managers are trying to move away
from the poor marketing image of no skills and high fees by
becoming more active. But he also said there's no guarantee
portfolio managers with high active share can beat their
benchmarks year after year.
"The case for active management is the opportunity to
outperform," Philips said, stressing the word opportunity. "But
higher costs are there and so is the risk of underperformance."
While a bad stock pick can undo any manager, recent academic
research reinforces the argument that active management provides
benefits to investors in the long-run.
Antti Petajisto, a former Yale University finance professor
who now works for BlackRock Inc, concluded that the most
active stock pickers in the industry have been able to beat
their benchmarks by about 1.26 percent a year after all fees and
expenses, according to his results published last year in the
Financial Analysts Journal.
Fidelity's Hogan said he believes investors will eventually
notice, turning the tide of money flows back in his company's
direction. "It would be great to get those flows, but they're a
lagging indicator," he said.
Still, executives from Fidelity and other mutual funds
acknowledge that a significant hurdle to drawing risk-averse
investors into actively managed funds is less about the
long-term performance, and more about the short-term volatility
that sometimes accompanies stock-picking.
The $1.5 billion CGM Focus Fund, for example, beat
the S&P 500 Index last year by 5.22 percentage points with a
37.61 percent return. Run by Ken Heebner, the fund's composition
was 97 percent different than its benchmark. But a key
volatility measure was nearly 80 percent higher than the S&P
500, according to Morningstar. The takeaway is that investing in
Heebner's fund is akin to a roller coaster ride.
Fidelity and OppenheimerFunds have said they want their
portfolio managers to pick stocks while keeping a sharp eye on
tracking error, which measures the volatility of a portfolio's
returns relative to its benchmark.
If done perfectly, an active manager can look different from
his benchmark without straying too far from the benchmark's risk
profile, said Laton Spahr, portfolio manager of the $2.4 billion
Oppenheimer Value Fund.
"With active share you can keep the risk profile of your
benchmark, but your returns can be better," Spahr said.