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The SPIVA Scorecard and Investing in Money-Losing Funds
Late in 2012, I reviewed the mid-year 2012 Standard & Poor’s Indices Versus Active scorecard. S&P has since updated the scorecard through year-end 2012, and I wanted to quickly hit on some of its findings. I’ll focus on the five-year results since those are long enough to actually begin drawing meaningful conclusions.
Starting first with the nine style box categories on the U.S. stock side we see that the indexes outperformed 80 percent of the actively managed funds over the five-year period ending December 2012. In every style category but one, the index outperformed at least 69 percent of the actively managed funds. The one exception was large value, where the index outperformed 50 percent of the actively managed funds.
Moving to international stocks, the report groups funds into four different categories:
  • Global funds
  • International large-cap
  • International small-cap
  • Emerging markets

On average, the indexes outperformed 58 percent of the active funds across these groups. In three of the four categories, the indexes outperformed at least 62 percent of the actively managed funds, but S&P reports that the index only outperformed 21 percent of the actively managed funds in international small-cap stocks.

For bond funds, S&P finds that the indexes outperformed 71 percent of actively managed funds across the 13 different categories, with the indexes outperforming 50 percent or more funds in every category but one.

Averaging across all three groups, we find that indexes outperformed 70 percent of the time, roughly jiving with historical results from other studies.

The Future

I fully expect that the results will only be worse in the future, particularly in bond funds. One of the big stories that has gone virtually unnoticed over the past couple of years (at least as best as I can tell) is the fact that bond fund expense ratios appear to be about the same as they’ve always been while yields have cratered. There’s no doubt in my mind there are a large number of bond funds at negative yields on a net of fund expense basis, meaning investors in those funds should expect to lose money going forward.

Why do I say this? Let’s look at a few Vanguard bond funds to benchmark what’s likely happening in the rest of the industry. Vanguard’s funds provide a good benchmark because their expenses tend to be much lower than the rest of the industry. Using Vanguard’s data, here were the net-of-fund-expense yields on a few of their funds as of the end of February:

  • Vanguard Short-Term Treasury Investor Shares — 0.10 percent
  • Vanguard Intermediate-Term Treasury Investor Shares — 0.72 percent
  • Vanguard Short-Term Bond Index Investor Shares — 0.39 percent
  • Vanguard Intermediate-Term Bond Index Investor Shares — 1.76 percent

So, let’s focus on what the yield for Vanguard’s short-term Treasury fund means. A yield of 0.1 percent means a reasonable expectation is that any dollars you invest in this fund will grow at just 0.1 percent per year after accounting for fund expenses. It also means that if you’re invested in a different fund that holds similar bonds as Vanguard’s fund that you can expect to lose money if they are charging an expense ratio that is 0.1 percent or higher than what Vanguard charges. Since Lipper reports that funds in Vanguard’s category charge about 0.44 percent, which is significantly more than Vanguard charges, many of those funds are actually expected to lose money.

Now, it’s obviously not rational for an investor to be in a bond fund that is expected to lose money, right? Faced with that information, the rational decision would be to move to a fund that isn’t expected to lose money or just move the money to a high-quality money market fund. So, why are investors doing this?

First, as we all know, inertia can be problem even if investors understand what’s going on. I happen to believe, though, that another major contributor to the lack of action is lack of quality information on what funds are yielding on a net-of-expenses basis combined with investors mistakenly looking at past returns as a gauge of what the fund will do in the future.

Random Links and Commentary of the Week

It sounds like the California Public Employees' Retirement System (CalPERS) is considering moving more of its investable assets to index strategies. I didn't realize this, but apparently over half of CalPERS' $255 billion in assets are already invested passively.

Jared Kizer is the director of investment strategy for The BAM ALLIANCE. See our disclosures page for more information.
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Re: The SPIVA Scorecard and Investing in Money-Losing Funds

Perhaps investors holding these funds have unrealized capital gains, so if they sell them now, they have to pay a lot of taxes... Thus it might be rational to hold the fund even if yields remain negative for some time. I have some active fund (stocks) with 40% unrealized capital gains, luckily TER has only 0.6%. I don't sell at the moment because of the tax problem, even though I wouldn't buy either if I wouldn't have it already.
at 4/10/2013 12:04 PM

Capital gains

Since the advantage of cap gain avoidance is largely a time value of money deal not sure avoiding that capital gain would be the rational thing to do if what you're invested in has a low or negative yield, meaning the time value of money could be negative.

Also, outside of tax-exempt bond funds held in taxable accounts taking the gain could make sense because you are effectively converting ordinary income taxation into capital gain taxation.

at 4/10/2013 3:11 PM

Re: The SPIVA Scorecard and Investing in Money-Losing Funds

If bonds in funds mature, and the funds buy new bonds, those bonds might have positive yields. Assume a fund yields -1% over the next year, and then yields become positive, then it would not be a good thing to realize capital gains now. Note that the yield curve predicts increasing yields. In an environment with flat yield curve over the long term, I would agree.

I do not know much about US tax law (it does not apply to me), but I suppose that selling a fund with capital gains makes you liable to pay some taxes, whatever the rate, not get a tax refund. I suppose further that the rate is a two digit number. Considering this as a transaction cost, it hardly ever makes sense to sell such positions.
at 4/10/2013 4:58 PM

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