Last Updated Jun 3, 2011 1:33 PM EDT
Using Morningstar data, we compared the returns of the Oakmark funds for which we have a passively managed fund against which we can benchmark it. Since Vanguard doesn't have funds in two of the three categories, we limited our comparisons to the funds of Dimensional Fund Advisors (DFA).
The period for the comparisons is the 10 years through May.
The Oakmark funds outperformed in one asset class, underperformed in another and roughly tied in the third, so there isn't much of a story there. However, an equal-weighted portfolio of Oakmark's fund in the three asset classes provided a return of 8.8 percent compared to the return of 8.4 percent for a portfolio of DFA funds. At least over the past 10 years, Oakmark has added some value over a passive strategy.
While it's unexpected that we would find such an outcome for any one fund family, we shouldn't be surprised to see some fund families produce above benchmark results. Given the number of fund families trying, randomly (luck-based outcome) we would expect some to outperform. In the past, we have looked at the results of many fund families, yet this is the first finding of alpha being generated.
With that said, that doesn't rule out the possibility that Oakmark's results are skill-based. And I certainly expect that we'll find others that will have outperformed -- though the evidence from academic studies gives me confidence that they will be far fewer than randomly expected.
Seeing Oakmark's performance, what should you do? First, remember that the overwhelming evidence from academic studies is that selecting active managers based on past performance is a losing strategy because there doesn't seem to be any persistence of outperformance beyond the randomly expected. Second, it's important that you understand that even successful skill-based active management tends to sow the seeds of its own destruction, as cash flows increase the already high hurdles (high expenses and market efficiency) that active managers face.
As cash flow inevitably follows alpha generation, either a fund will experience greater market impact costs, or it'll be forced to diversify its holdings further. This creates the problem of being a closet index fund (a fund whose holdings closely match its benchmark). As funds become more index-like, their incremental expenses must be spread over the small and smaller portion of the portfolio differentiated from the index.
This explains why studies on pension plans have found that while they hire managers with very successful track records, the alphas usually disappear after hiring. The evidence can be found in the chapter on pension plans in The Quest for Alpha.
There's one last important point for you to consider. Studies on actively managed funds have found that the few winners tend to outperform, as Oakmark has, by relatively small amounts, but the far greater majority that fail tend to underperform by much larger amounts. Thus, the risk-adjusted odds of outperforming are much worse than they appear if you fail to account for this. That's another reason why active management has been called the loser's game.
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