By James Saft
(Reuters) - One select group of active asset fund managers is actually earning their keep, outperforming the market substantially between 2000-2012.
One small problem: unless you are a large institution they are not taking your money.
A new working paper, covering $25 trillion of assets under management, found that managers who handle money for institutions like pension funds have beat the market.
“We show that one group of active investors, institutional delegated investors, may profit at the expense of non-delegated investors,” Joseph Gerakos and Juhani Linnainmaa of the University of Chicago and Adair Morse of the University of California Berkeley write. (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2733147)
“Given the size of the asset manager fund market, our findings imply that the literature on active management overlooks approximately two-thirds of actively managed capital.”
These managers outperform the market by 96 basis points a year on a gross basis, generating a net alpha, or outperformance, of 49 basis points for clients net of fees and other costs, according to the study. What’s more, they are generating these returns with only 88 percent of the volatility of the overall market, implying they are producing above-market returns with below-market risk.
Because of lower disclosure requirements, institutional investment returns have generally been more opaque to researchers, who in turn have concentrated instead on mutual fund data.
By gaining access to the database of a global investment consultant firm which specializes in this market, the researchers were able to track assets, returns and fees on more than 22,000 funds representing more than half the $48 trillion institutions had invested with institutional funds at the time.
Earlier studies of active mutual fund managers have generally not been encouraging, finding, in various studies, evidence both of shaky performance when fees are taken into account and so-called closet-indexing, the practice of taking only slight deviations from benchmark.
The asset fund managers in the study, however, do deviate from their benchmarks substantially, with a tracking error of 8.7 percent by one measure. This implies that they are very likely genuinely active fund managers.
The money at stake is enormous: the annual outperformance generates $260 billion in gains for end investors and $172 billion in fees per year over the 13-year period. That $172 billion is about twice the fees paid by retail mutual fund investors over the same period, despite being lower on average per dollar, at 47 basis points annually.
GOOD NEWS, LESS GOOD IMPLICATIONS
Yet wrapped within all of this relatively good news about active institutional fund mangers comes some less good implications, both for their business model and for the performance of those outside the scope of the study.
The study also considered whether that $172 billion a year in fees was worthwhile, particularly for large institutions which have or could build expertise in-house. Using tradable indices, the authors find that institutions using fairly standard techniques could have achieved broadly similar risk-adjusted returns for about the same cost.
That’s goodish news if you are an institutional fund manager, but not so good news are market developments of recent years, particularly cheap, highly liquid exchange traded funds.
“Our estimates also imply that the introduction of liquid, low-cost-factor ETFs is likely eroding the comparative advantage of asset manager funds,” the authors write.
In other words, doing it for yourself is getting cheaper, which rather implies that more large institutions will do so in the future.
There is of course another angle to all of this. While wise investing might conceivably improve economic output, and returns to all investors, by definition one manager’s outperformance comes at the expense of someone else’s underperformance. So if we have a study, as we do, showing that 13 percent of total worldwide investible assets are outperforming on the broadest basis by 119 basis points a year, then everyone else is underperforming by 49 basis points a year.
Now, who could that be?
A 2010 study by Eugene Fama and Kenneth French showed that retail mutual funds produce outperformance, or alpha, of just about nothing.
That leaves institutions who don’t delegate their money to outside managers and retail investors.
We can’t know, but it seems a good guess that institutions which are large and sophisticated enough to manage money in-house probably don’t do too badly.
As for retail, for 21 years consultants Dalbar have been running a study which shows that the average retail mutual fund investor lagged their benchmark by 4.66 percentage points a year.
If retail are that poor at timing fund buying and selling, they may be even worse at self-directed investing.
So, the big benefit at the cost of the small, but at least within a marketplace which is competing away advantage.
Could be worse.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)