Last Updated Jun 6, 2011 9:32 AM EDT
In the past, we have looked at the performance of such active managers as AllianceBernstein, Muhlenkamp, Northern Trust and Waddell & Reed. I was asked to take a look at Fidelity and see if its active funds had added value. When first asked, I thought "Sure, we can do that." But the task became a bit more daunting when I learned that Fidelity has more than 1,000 active funds and more than $1 trillion in assets under management.
To whittle the list down to a manageable number, I asked my Right Financial Plan co-author Kevin Grogan to screen for the 10 largest actively managed equity funds with at least 10 years of history. I only included funds that have a Dimensional Fund Advisors and Vanguard equity counterpart, so funds that mix US and international equities or have significant allocations to fixed income were excluded.
To enable us to look at how a portfolio would perform, we want to cover the four major U.S. asset classes of large-cap, large-cap value, small-cap and small-cap value, as well as the two major international asset classes of developed and emerging markets. Thus, while the Fidelity Emerging Markets Fund (FEMKX) isn't among its 10 largest, it's included in the analysis. And note that because Fidelity didn't have a small-cap value fund with 10 years of data, we had to omit that asset class. The analysis covers the 10-year period through May. As you consider the data, keep in mind that the screening process I chose creates biases that favor Fidelity.
Biases in the Data
The first bias is survivorship bias. Funds that performed poorly may no longer be around. Their poor performance was buried either in a merger or by sending the fund to the mutual fund graveyard in the sky. This bias may explain why Fidelity doesn't have any small-cap value funds with 10 years of data.
The second bias is that by using AUM as a screen, the funds that have performed the best will likely have the most assets. There are two reasons for this. The first is that superior returns will obviously increase AUM. The second is that investors chase performance. So, good performance leads to more cash inflows. (Of course, the new investors didn't benefit from the past performance.)
While keeping the biases in mind, we'll compare the returns of Fidelity's active funds to the returns of passively managed funds in the same asset class, a Vanguard index fund and a fund from DFA. As we have done in the past, we'll also consider that investors don't invest in just single funds. Instead, they build portfolios of funds, diversifying their risks. So we'll compare the returns of a Fidelity portfolio with the returns of portfolios of Vanguard index funds and DFA funds. To arrive at each portfolio's return, we'll equal weight the returns of multiple funds from the same asset class, and then equal-weighted the returns from each asset class.
Even with the biases in the data, a portfolio of Fidelity's active funds underperformed a portfolio of DFA funds by 0.9 percent (7.7 percent vs. 6.8 percent) and tied a portfolio of Vanguard index funds.
The bottom line is that it would be hard to claim that Fidelity is adding value.
As a coda to the analysis, I thought I would present the evidence on the performance of Fidelity's one-time flagship fund, Fidelity Magellan (FMAGX). Over the 10-year period, it returned just 0.8 percent, 1.7 percent below that of the Vanguard 500 Index Fund (VFINX). Its poor performance can't be explained by its higher expense ratio, as the negative alpha is more than three times the difference in their expense ratios. Magellan, which at one point was the largest mutual fund, has seen its assets shrink to about $23 billion. The loss of assets wasn't a result of negative returns, but of investors fleeing the poor performance.
In light of the evidence presented above, and the fact that Fidelity is now one of the leading providers of index funds, one can only wonder how Edward Johnson, the chairman of Fidelity, feels now about his once bold statement: "I can't believe that the great mass of investors are going to be satisfied with just receiving average returns. The name of the game is to be the best."
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Does Waddell & Reed Back Up Its Claims? Does Northern Trust Add Value? John Hancock: Does It Add Value? The Difference Between Active Management and Passive Management Why a Falling Dollar Shouldn't Stoke Fears of Inflation
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