Cherry-Picking Data to Make Active Managers Look Good

“Active managers have been much more successful over the past decade than is commonly realized,” asserts Neuberger Berman. The asset manager backs up this statement with return data from the last 20 years. It’s a bold statement intended to spark interest in actively managed funds, which the company offers. Whether you agree with the statement depends largely on how much you think the data adjustments are justified.

The study’s authors purposely did not look at the entire universe of mutual funds. In explaining their rationale, they write, “Instead of comparing the performance of an index against an entire universe of active strategies, it’s more appropriate to reframe the conversation to include only those managers in the top three quartiles of performance and thus eliminate a small cohort of poorly performing funds unlikely to attract significant investment flows.” Based on this, they conclude that 84% of active managers have beaten the S&P 500 index over the past 20 years.

Unlike the children from Garrison Keillor’s fictional Lake Wobegon, not all funds are above average. Some are flashes in the pan, doing well over a certain period of time before crashing and eventually disappearing from the fund universe. While Neuberger Berman included funds that were liquidated, by excluding the worst-performing quartile, it is possible that those funds were only included during their good years and excluded during their lousy years. Such a viewpoint assumes that an investor would have enough foresight to predict which funds would have maintained their outperformance AND got out of those same funds before their returns fell to the bottom quartile. Using the full universe of actively managed funds would have resulted in a worse batting average.

The report bears this out. The rolling 10-year period analysis shows large-cap blend funds ranking in the top three quartiles beating the S&P 500 66% of the time. When the all-funds universe is analyzed instead, the batting average falls to 33%—a big difference.

In addition to excluding certain funds when they did poorly, the analysis also used rolling periods as opposed to a straight 20-year holding period. We know some actively managed funds will outperform over a given time period. We also know that the best funds over, say, a five-year period are frequently not the best ones over the next five years. While investors may jump in and out of funds, it’s a big stretch to assume that the majority of investors—individual or institutional—successfully jump from one outperformer to another outperformer.

Then there are the returns of the last 10 years, which the report’s authors attempt to dismiss. They cite higher correlations within S&P 500 (meaning the returns of large-cap stocks have been more similar) as “depriving active managers of the opportunity to distinguish winners from losers through fundamental research.” Yet, the rationale for accepting the higher expense ratio of actively managed mutual funds is to benefit from the skill of their managers. While certain managers (e.g., value fund managers) can be given a pass because their types of strategies have simply been out of favor since 2007, the entire set of active managers should not be. These managers have been paid to beat the market.

Throughout the history of the markets, performance data has been cherry-picked, twisted and sometimes tortured to tell a story that someone selling an investment-related product wants you to hear. While there are many of us in the investment industry who show the data in open light, there are enough questionable claims to warrant maintaining a degree of skepticism. With Neuberger Berman, it is simply a case of cherry-picking data to put active mutual funds into a more positive light.

As far as actively managed mutual funds are concerned, there are some fund managers who have beaten the S&P 500 or another appropriate benchmark over an extended period. Are they easy to identify in advance? No. For those who want to try, a place to start is to look for funds with lower expense ratios, a systematic approach to investing and a truly active approach to investing. Comparatively smaller size in terms of assets managed relative to their peers is also a good trait to seek, since large amounts of investor inflows can wreck even good strategies. You will also need a good dose of patience because even good managers will incur periods of underperformance.