It’s commonly believed that in the long run, passively managed portfolios represent a better investment bet than active funds. However, new research focusing on US mutual funds suggests three factors that could reverse the relationship.
According to a study by the Capital Group entitled Selecting Managers Who Have Delivered Better Retirement Outcomes
, actively managed funds available in the US that shared three traits–low downside capture ratio, low expenses, and high firm manager ownership–have “consistently outpaced benchmark indices and the broader equity fund universe in the distribution phase”.
How did they arrive at this conclusion? The global investment management firm performed a two-step screening process on a population of actively managed mutual funds. The population was taken from a Morningstar US database of large-cap actively managed funds.
The first screening selected for funds with high downside capture ratio–that is, the ones that got a high positive return when the return of a selected index was negative.
They then screened the resulting subset for low net expense ratios and high management ownership. The top quartile was sought for US Large Cap funds and the top two quartiles (that is, the top 50%) for Foreign Large Cap, Moderate Allocation and World Allocation funds.
The research then looked at hypothetical US$500,000 lump sum investments in the four categories of large-cap equity strategies, assuming a 4% initial withdrawal, increasing 3% a year for 20 years ending on December 31, 2015.
For each of the four categories, researchers noted the percentage of instances wherein the ideal portfolio–consisting of those funds that possessed all three properties–outperformed that of an index portfolio, finding that the ideal funds “would have had close to 100% success rates for three of the four categories we studied”.
The researchers also looked at hypothetical scenarios with 4%, 5%, and 6% initial withdrawal rates. In all three withdrawal scenarios, they saw that the ideal active portfolios generated significantly higher results than the index portfolio.
While the results are based on scenarios taken from US mutual funds, Canadian investors with increasing concerns on their finances upon retirement are likely to consider these results very interesting.
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