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Fund Performance Before and After Fees: Does It Matter?
Don't have time to read the underlying paper now, but a few thoughts come to mind regarding his first point. Namely that funds are reportedly outperforming "less often" before fees.
He uses "less often" to mean smaller percentage. We don't know if the fund universe has grown with lots of lousy funds that decrease the percentage of successes or that there are actually fewer funds outperforming.
More important is Sharpe's simple argument that before fees, the average dollar invested in the market must match market performance. If fewer funds are outperforming, that strengthens the possibility (above) that there are just more lousy (small) funds. The data doesn't show that actively managed dollars (pre-expense) are doing worse now. They can't be, per Sharpe.
One needs to be precise here. Actively managed dollars invested in the market must on average match market performance. If the cash drag on funds has increased (percentage of fund assets on the sidelines in cash) has increased, then of course the average fund performance will have decreased. But the average performance of the fraction of fund dollars actually invested will not have. They may just be getting held back more forcefully by larger cash drags.
The average actively managed cost figures quoted are for actively managed dollars (i.e. dollar-weighted average of funds), and not the simple average expense ratio of actively managed funds as stated in the piece. See, e.g. here. This is important because while the dollar weighted average of ERs is dropping, that doesn't say anything about the simple average of ERs. It can easily be the case that the simple average isn't dropping at all; merely that people are moving their dollars to cheaper funds. This seems to put his conclusion about fund expenses being unrelated to performance in doubt - because he's looking at performance fund-by-fund, not weighted by dollars.
Ptak at M* knows what he's writing about and what gaps exist in his (and others') work. I'd start with his paper to understand what's really going on.
Whether he was simply lazy or dishonest, I was bothered by the fact that for after-tax performance he compared small cap funds with the S&P 500:
For the “after fee” performance record, we ... look[] at mutual fund out and underperformance versus the S&P 500 ... [O]ver the 15-year investment horizon (2002 to 2017), ... one in 23 small-cap managers were able to outperform their benchmark index after fees.
This use of a wrong "benchmark" is made more egregious by that fact that he says that large cap funds are leading (his point #3). So we may assume that the large cap benchmark (S&P 500) did better than small cap benchmarks.
He compared small cap funds with a large cap index that outperformed an appropriate small cap benchmark, thus making small cap funds appear worse.
Honest in the sense of "mea culpa"? Perhaps. Intellectually honest? I'm not so sure.
Comments
He uses "less often" to mean smaller percentage. We don't know if the fund universe has grown with lots of lousy funds that decrease the percentage of successes or that there are actually fewer funds outperforming.
More important is Sharpe's simple argument that before fees, the average dollar invested in the market must match market performance. If fewer funds are outperforming, that strengthens the possibility (above) that there are just more lousy (small) funds. The data doesn't show that actively managed dollars (pre-expense) are doing worse now. They can't be, per Sharpe.
One needs to be precise here. Actively managed dollars invested in the market must on average match market performance. If the cash drag on funds has increased (percentage of fund assets on the sidelines in cash) has increased, then of course the average fund performance will have decreased. But the average performance of the fraction of fund dollars actually invested will not have. They may just be getting held back more forcefully by larger cash drags.
The average actively managed cost figures quoted are for actively managed dollars (i.e. dollar-weighted average of funds), and not the simple average expense ratio of actively managed funds as stated in the piece. See, e.g. here. This is important because while the dollar weighted average of ERs is dropping, that doesn't say anything about the simple average of ERs. It can easily be the case that the simple average isn't dropping at all; merely that people are moving their dollars to cheaper funds. This seems to put his conclusion about fund expenses being unrelated to performance in doubt - because he's looking at performance fund-by-fund, not weighted by dollars.
Ptak at M* knows what he's writing about and what gaps exist in his (and others') work. I'd start with his paper to understand what's really going on.
Did it take a study to find out that active does better in down markets and passive outperforms in bull markets? Duh? Indexes hold little if any cash.
He compared small cap funds with a large cap index that outperformed an appropriate small cap benchmark, thus making small cap funds appear worse.
Honest in the sense of "mea culpa"? Perhaps. Intellectually honest? I'm not so sure.