After reviewing a study on the composition of mutual fund portfolios, Larry Swedroe concludes investors cannot rely on an active fund’s name, or even its stated objective, when seeking exposure to factor characteristics.
Most of the focus of the literature on active mutual funds has been on the question about their performance and the related issue about whether or not active fund managers have skill. On the other hand, the composition and characteristics of mutual fund portfolios have largely been ignored.
Martin Lettau, Sydney Ludvigson and Paulo Manoel contribute to the literature with their December 2018 study “Characteristics of Mutual Fund Portfolios: Where Are the Value Funds?”, which provides a comprehensive analysis of portfolios of active mutual funds, ETFs and hedge funds through the lens of risk (anomaly) factors such as size, value and momentum.
Among the questions they try to answer are: “To what extent do active fund managers exploit these factor premia? If there are limits to arbitrage, do active funds contribute to the existence of these anomalies or do they overweight underpriced stocks? And, more broadly, what set of strategies is available to retail investors via active funds?”
Their analysis focused primarily on holdings of mutual funds (versus regressions of fund returns). Their data sample covers the period 1980 through June 2016 and includes 2,638 funds (574 “value” funds, 1,130 “growth” funds, 955 ETFs and 114 hedge funds).
Following is a summary of their findings:
Lettau, Ludvigson and Manoel concluded: “Our results suggest that active mutual funds do not systematically hold the stocks with characteristics associated with high returns and thus are unlikely to contribute to any shrinking of factor premia during the sample period.”
They did caution that, while their sample of mutual funds and ETFs was exhaustive, they only observed portfolio holdings of a very small subset of small hedge funds. Thus, they could not rule out that (larger) hedge funds tilt their portfolios toward proﬁtable characteristics.
The authors’ findings have important implications for investors: You cannot rely on a fund’s name or even its stated objective when seeking exposure to factor characteristics. You have to take a deeper dive and look into the fund’s actual holdings.
It was interesting to note that, of the 10 funds with the highest BtM score, three were from Dimensional Fund Advisors (their U.S. small value, targeted value and large value funds), and a fourth was a fund for which they are the subadvisor, a large value fund (scores between 4.0 and 4.1).
This commentary originally appeared May 22 on ETF.com.
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