It’s hard for active managers to beat an index. And it’s just as hard for manager selectors to pick active managers who can beat their indices.
To prove this point, let’s consider the Morningstar domestic ‘Manager of the Decade’ nominees from 2009 and how they’ve done since.
The short answer? Not one of them has beaten a relevant index for the past eight or so years. The longer answer? The above fact doesn't tell the whole story.
The original nominees for Morningstar’s ‘Manager of the Decade’ award for domestic equities in 2009 were Bruce Berkowitz of the Fairholme fund, Charlie Dreifus of Royce Special Equity, Don Yacktman of the Yacktman fund, Joel Tillinghast of Fidelity Low-Priced Stock and Steven Romick of FPA Crescent.
Full disclosure: I was part of the selection process, in which 25 or so Morningstar analysts recommended managers to be considered for the award. If I remember correctly, I voted for Romick, although I was also (and continue to be) fond of the Yacktman and Royce Special Equity funds. I own all three in personal accounts.
Choosing the right yardstick
In measuring the performance of these funds, the S&P 500 is not the correct comparison for all of them, so I’ll try to make comparisons against best-fit indices. However, it is appropriate to benchmark two of these funds – Fairholme and Yacktman – against the S&P 500.
The years have not been kind to the Fairholme fund, and its recent woes are well-documented. It has struggled mightily with bets on retailer Sears, real estate firm The St. Joe Company and preferred securities of Fannie Mae and Freddie Mac. Its annualized return of 4.22% and Sharpe ratio of 0.28 since Berkowitz’s nomination back in 2009 are abysmal versus the index’s 14.02% annualized return and 1.15 Sharpe ratio (see Figure 1).
The Yacktman fund has done better, although Don Yacktman has now retired. Holding a core group of consumer products companies and older technology names such as Microsoft, Oracle and Cisco, Don’s son Stephen and co-manager Jason Subotky have posted an annualized return of 11.43%. A slug of cash has kept the fund more than two percentage points behind the index, but the added stability of the cash has helped it to manage volatility. The fund has posted an impressive Sharpe ratio of 1.14 versus 1.15 for the index.
Volatility may not be the best measure of risk, but a smooth ride can help investors avoid trading the fund badly. Indeed, over the past 15 years through the end of August, the Yacktman fund has produced a 10.48% ‘investor return,’ as calculated by Morningstar, which compares favorably with the fund’s 10.43% total return over that period.
Riding it out
The group of funds measured against the Russell 2000 Value index has also experienced some mixed results (see Figure 2). The Royce Special Equity fund has delivered an annualized return of 10.28%. That’s perfectly respectable in absolute terms, but it lags the index’s 13.19% return – as does the Fidelity Low-Priced Stock fund’s 12.49% annualized return. However, both posted thorougly decent Sharpe ratios. The Royce fund’s 0.75 ratio was close to the index’s 0.81, and the Fidelity fund’s Sharpe ratio of 1.03 exceeded the index’s metric by a significant margin, helping Tillinghast to deliver strong volatility-adjusted returns.
Finally, there is FPA Crescent, an allocation fund. The fund typically keeps between 50% and 60% of its assets in stocks and then rotates the remainder into virtually anything else that its value-oriented managers – Steven Romick, Mark Landecker and Brian Selmo – view as a bargain. Sometimes, a slug of that remainder will be deployed aggressively in junk bonds (usually after they’ve hit the skids), but at other times it can sit patiently in cash.
The FPA Crescent fund has lagged the Vanguard Balanced Index fund by a little more than one percentage point annualized, but it has beaten a balanced index made up of 60% the MSCI All-Country World index and 40% the Bloomberg Barclays US Aggregate by nearly two percentage points annualized (see Figure 3). The fund has around 8% of its assets in non-US stocks.
So what conclusions can be drawn from all this? The fund managers that the Morningstar analysts nominated to be ‘Manager of the Decade’ in 2009 haven’t exactly covered themselves in glory. But then, fund management and fund selection are both difficult businesses.
But it’s not all bad news. Volatility-adjusted returns sometimes improve the comparisons against the indices. Also, investors should consider that the period since the award nomination has been a long bull market. And as Romick argued in the Journal of Portfolio Management back in 2015, the correct way to judge performance is over a full market cycle, which will rarely fall neatly over 10 years.