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3D Asset: In Defense of Active Management (Sort Of)

Unless specified otherwise, all performance and market data are sourced from Bloomberg. For all indices, performance reflects total returns which is change in price plus reinvested dividends and/or interest, if any. MSCI index total returns are shown net of dividend withholding taxes.

07/21/2016

Another Year, Another Time of Struggle for Active Management
Savita Subramanian, Quantitative Strategist at BofA/Merrill Lynch, just published an update to their periodic review of active managers.  According to the report, “just 18% of large cap funds outperformed the Russell 1000 in 1H16, so far making it the worst year for active funds in history.”  I decided to construct a more refined list of active U.S. large blend mutual funds in Morningstar where I screened out multiple share classes, sector funds, passive funds, and low/managed volatility.  I arrived at a list of 347 funds where the 1H16 median return is 1.81% versus 3.84% for the S&P 500.  This ranks the index at 22% of the funds within this list, fairly close to the BofA observations.   And for the privilege of realizing this underperformance, investors in this list of funds are paying an average fee of 0.67%.

There are many market headwinds facing managers this year (similar to what has been observed over the last several years).  Despite a strong 2nd quarter, small caps continue to lag large caps with the Russell 2000 returning -1.59% versus 3.74% for the Russell 1000.  This has also been a largely one-directional market with dividend-focused equities (or bond proxies) generating the lion’s share of U.S. equity returns.  S&P Telecom and Utilities have returned 24.8% and 23.4%, respectively while traditional growth sectors such as consumer discretionary, health care, technology, and financials have significantly lagged the broader market (Exhibit 1).  Telecom and Utilities tends to be underrepresented in active mutual funds as indicated in Exhibit 2.

Exhibit 1 – 1H16 S&P Sector Returns: Safe and Defensive Has Been the Place to Be

Exhibit 2 – U.S. Large Cap Fund Median Sector Exposure Versus S&P 500 Index

Finally, it’s been a one-directional market with low volatility / dividend strategies outperforming all other styles (Exhibit 3).

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