A quick note before I start with this week’s commentary. Last week, we received questions from several members about whether we had plans to run a special promotion on our Dividend Investing newsletter. Well, I don’t know if it was the requests, the madness of this year’s NCAA men’s basketball tournament or just the warmer spring weather, but our marketing vice president decided to honor the requests. You can now subscribe to AAII Dividend Investing for just $99 per year, but you have to act fast as the sale ends on Sunday.
American Funds says that some actively managed funds are better than passive (index) funds. Specifically, the company argues that actively managed funds with low expense ratios and high levels of manager ownership (a group that Amercian Funds calls “Select Active”) outperform their index peers. The outperformance is evident over one-, three-, five-, and 10-year rolling periods. I’ll discuss the returns first, followed by the criteria and the caveats to the analysis.
Select Active funds topped the S&P 500 index by an average of 0.30% over rolling one-year periods. Over longer periods, the annualized average advantage for the Select Active funds was 0.70% for rolling three-year periods, 1.04% for rolling five-year periods and 1.07% for rolling 10-year periods. Those funds topped the large-cap index 55%, 64%, 77% and 95% of the time during the respective periods. The analysis was run from January 1996 through December 2015. (A summary of the findings is available on the American Funds website.)
Low expense ratios were defined as using the lowest net expense ratio (NER) for all observed Morningstar categories between January 1996 and December 2015. (We use Morningstar fund data for both our mutual fund and exchange-traded fund guides.) American Funds gives a rule of thumb for low expense ratios as being below 0.99% for large-cap domestic funds. Expense ratios for institutional and advisory share classes would be approximately 25 basis points lower, or below 0.74%.
Manager ownership was calculated using Morningstar screens of manager holdings at the firm level. American Funds assigned a weighted average to do the rankings. An alternative method would be to seek out firms “that had 55% or more assets in the fund family complex in which at least one fund manager had invested a minimum of $1 million.” A fund’s statement of additional information will have this data. You can find it on a fund family’s website, though you may have to look closely to identify the location. While not hidden, it’s not always obvious either. The exact location varies by website.
The numbers are intriguing, but do not represent what an investor would realize in a real-world environment. Sales charges, such as front-end loads (fees for purchasing a fund), are excluded and—if they are levied—would reduce the returns realized by some of the Select Active funds. The portfolios were rebalanced monthly, which is easy to do with a study but is often not feasible in an actual portfolio. The number of funds held was not given and may be more than an individual investor would want to manage or be able to invest in. The analyses shared with me also did not consider mid- and small-cap funds.
Nonetheless, the study suggests a starting point for investors who prefer active management. Low expense ratios reduce the hurdle an actively managed fund has to jump over just to keep its performance even with an index fund. (Our mutual fund guide lists the annual expense ratio, any load and how tax-efficient a fund is.) Higher levels of fund ownership should suggest that the monetary interests of the fund's manager and the directors are aligned with fund shareholders. Still, you should investigate the fund manager’s tenure (longer is preferable), the fund’s size (too many assets under management are a hindrance to outperformance) and whether the fund follows a repeatable process or not (read the fund’s materials and, if available, the manager’s commentary).
- Qualitative Guidelines for Mutual Fund Selection – Beyond the numbers, the frequency of communication, the portfolio holdings and the tenure of the manager can help you assess the attractiveness of a fund.
- The Truth About Top-Performing Mutual Funds – Even the best mutual fund managers will incur periods when they underperform, but there is a reward for sticking with them.
- How Likely Is a Market Downturn? – AAII president John Bajkowski explains why you shouldn’t worry about whether the answer to this question is “very likely” or “not in the foreseeable future.”
- What Traits Do You Look for in a Mutual Fund? – Tell us on the AAII.com Discussion Boards.
As a reminder, the U.S. financial markets will be closed tomorrow in observance of Good Friday. On behalf of everyone at AAII, I wish those who are observing the holiday a Happy Easter.
A small number of S&P 500 member companies will report earnings next week: Lennar Corp. (LEN) and McCormick & Co. (MKC) on Tuesday and Carnival Corp. (CCL), Micron Technology (MU) and Paychex (PAYX) on Wednesday.
The first economic reports of note will be January international trade data, February personal spending and income and the National Association of Realtors’ February pending home sales index. These will be released on Monday. Tuesday will feature the January Case-Shiller home price index and the Conference Board’s March Consumer Confidence index. The March ADP Employment Report will be released on Wednesday. Thursday will feature the March Chicago PMI. March employment data (including the change in nonfarm payrolls and the unemployment rate), the ISM’s March manufacturing survey, the University of Michigan’s final March consumer sentiment survey and February construction spending will be released on Friday.
Fed Chair Janet Yellen will speak on Tuesday. Also speaking will be San Francisco president John Williams and Dallas president Rob Kaplan on Tuesday; Chicago president Charles Evans on Wednesday and Thursday; New York president William Dudley on Thursday; and Cleveland president Loretta Mester on Friday.
The Treasury Department will auction $26 billion of two-year notes on Monday, $34 billion of five-year notes on Tuesday and $28 billion of seven-year notes on Wednesday.
- Protecting Against a Price Drop: Puts Versus Stop Orders
- The Individual Investor’s Guide to Personal Tax Planning 2015
- Surviving a Loss: Smart Steps for Coping With Widowhood
The level of short-term pessimism among individual investors continues to pull back, according to the latest AAII Sentiment Survey. Bearish sentiment is now down by a cumulative 25 percentage points since early February. However, optimism still remains below average and neutral sentiment is at an unusually high level.
Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 3.8 percentage points to 33.8%. The increase was not large enough to prevent optimism from staying below its historical average of 39.0% for the 20th consecutive week and the 53rd out of the past 55 weeks.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 0.7 percentage points to 42.5%. This is the eighth consecutive week and the 60th in the past 64 weeks with a neutral sentiment reading above its historical average of 31.0%.
Bearish sentiment, expectations that stock prices will fall over the next six months, declined 3.1 percentage points to 23.7%. The drop put pessimism at a new low for 2016, and just barely above the December 31, 2015, reading of 23.6%. Bearish sentiment has now been below its historical average of 30.0% for four consecutive weeks.
Though pessimism has declined considerably over the past nine weeks, it still remains within its typical historical range. More importantly, optimism continues to stay at below-average levels, with only one in three survey respondents currently describing their short-term outlook as "bullish."
Though some individual investors are encouraged by the market’s rebound off of its February lows, sustained economic growth and still comparatively low energy prices, others fret about the possibility of further declines in stock prices, the pace of economic growth in the U.S., the pace of economic growth in China, tensions in the Middle East, the rate of earnings growth and prevailing valuations. Frustration with Washington politics also continues to be expressed.
This week’s special question asked AAII members for their opinion about the recent rebound in stock prices that began in mid-February. There was no consensus. The largest group of respondents (22%) said that the rebound will not last. Several respondents in this group described the rebound as a temporary occurrence or a bear market rally. Slightly more than 14% of respondents said that the rally was a reaction to oversold conditions, excessive pessimism and short-term trading. Nearly 9% said that stock prices are tied to swings in commodity prices, especially oil. About 7% expect the stock market to remain volatile. Almost 5% of respondents expect stocks to rise more, while 4% attributed recent buying activity to the Federal Reserve and low interest rates. An additional 4% described the rebound as being normal or otherwise expected.
Here is a sampling of the responses:
- “A bear market rally.”
- “With oil prices bottoming, one would expect a rebound.”
- “I expect it to drop and to continue to be up and down.”
- “I think it was a correction of the excessively negative sentiment that prevailed just after the first of the year.”
- “I think things will slowly improve, with periodic setbacks.”
- “I’m surprised at the extent of the rebound and the turnaround in oil prices.”
Bullish: 33.8%, up 3.8 points
Neutral: 42.5%, down 0.7 points
Bearish: 23.7%, down 3.1 points
Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Local Chapter Meetings
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March 10, 2016 A Gold Fund’s Debacle Highlights Risks
March 3, 2016 Buffett on How Earnings and Assets Can Be Misstated
February 25, 2016 The Factors to Include on Your Retirement Readiness Checklist
