American Funds says it was able to isolate two factors that could identify active funds that consistently outperform their benchmark indexes over both the short and long term.
“We found that low fees really matter,” Deschenes says. “When you throw out the most expensive funds and focus on the least expensive quartile of active funds, you double your chances for success—40 percent of those managers beat the index. When I add manager ownership to the screen, I can take my success rate well above the 50 percent threshold.”
When American Funds’ researchers screened the Morningstar database of U.S. large-cap equity funds active funds for low expense ratios and high manager ownership, the resulting set of “select” active funds slightly outperformed their indexes year-over-year as of June 30. If $100,000 had been invested in an average “select” fund on July 1, 2015, it would have outperformed the S&P 500 by an average of $350 over the year, according to the study.
The outperformance of the “select” active funds appears persistent and cumulative over longer time periods—at a 10-year investing horizon, a $100,000 investment in “select” active funds would have outperformed the S&P 500 by an average of $16,000, according to American Funds.
All told, the “select” active funds outperformed their index 55 percent of the time on a rolling one-year basis, 65 percent of the time on a rolling three-year basis, 76 percent of the time on a rolling five-year basis and 89 percent of the time on a rolling 10-year basis, according to American Funds.
While Morningstar research has repeatedly linked low expense fees to fund performance, American Funds spurred new research on the impact of manager ownership.
“We were actually asked by Morningstar if we had ever looked into manager ownership,” Deschenes says. “We had always believed in it, but we had never thought of it as a differentiating characteristic. We took the S&P’s data going back to 2004 and then hired a company to read every single SEC filing made in the past 12 years to create a complete data set of ownership. We found that ownership has a positive impact.”
Deschenes says that low-fee managers who own significant portions of their funds tend to be more conscientious decision makers.
“These factors are identifying stewardship,” Deschenes says. “Investors should be focusing on points of goals-based alignment and stewardship instead of on the active-passive debate.”
Deschenes says that by looking over longer rolling time periods, American Funds’ research more accurately reflects how investors build wealth over several years or decades.