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Philip van Doorn

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Aug. 5, 2015, 4:59 p.m. EDT

This is how a mutual fund can beat an index fund

Investors need patience to let a long-term strategy pay off

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By Philip van Doorn, MarketWatch


Bloomberg News/Landov
Apple is the largest holding of AJO Partners, across all portfolios.

You’ve probably read stories that say investors are better off in index funds rather than actively managed mutual funds.

That is, for the most part, true for the average investor, who might not be able to resist the temptation of “chasing after good performance.” There is a tendency to look at annual returns of actively managed mutual funds and then decide whether to jump in or switch to a different fund.

Vanguard founder John Bogle said in a recent interview with Time that the securities industry “encourage[s] investors to trade about $32 trillion a year. So the way I calculate it, 99% of what we do in this industry is people trading with one another, with a gain only to the middleman. It’s a waste of resources.”

The problem with that type of “trading” behavior is that actively managed funds tend to have long-term strategies that don’t necessarily work well over short periods in certain market conditions. And the fund managers are not likely to change their strategies to match the current mood of the market.

Judging long-term strategies by short-term performance not only hurts investors in their own decision making, it also punishes the companies they invest in. That is because compensation for many executives is tied to short-term results, making them far less likely to have long-term vision for the companies they manage.

Two examples of actively managed mutual funds we discussed recently were the Permanent Portfolio /zigman2/quotes/205061618/realtime PRPFX -0.68%  and the Jensen Quality Growth Fund /zigman2/quotes/200918620/realtime JENSX +0.45% . Both funds have underperformed the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.06%  over the past five and 10 years, but it’s a different story over 15 years. The fund managers admitted their strategies weren’t suited for the current bull market, driven in great part by the Federal Reserve’s decision to hold short-term interest rates near zero since late 2008 and the policy of expanding the U.S. money supply by enlarging its balance sheet nearly five-fold.

Both funds have beaten the average total returns of the S&P 500 Index over the past 15 years:

Ticker Average annual return - 5 years Average annual return - 10 years Average annual return - 15 years
Permanent Portfolio /zigman2/quotes/205061618/realtime PRPFX 3.20% 6.01% 7.75%
Jensen Quality Growth Fund /zigman2/quotes/200918620/realtime JENSX 13.59% 7.64% 6.29%
S&P 500 Index /zigman2/quotes/210599714/realtime SPX 16.24% 7.72% 4.61%
Source: Morningstar

The 15-year cumulative returns of 205% for the Permanent Portfolio and 144% for the Jensen Quality Growth Fund easily exceed the 97% return of the benchmark S&P 500.

A value fund that sweats the small stuff

Ted Aronson, managing principal of AJO Partners, discussed his firm’s role as the subadviser for the BPV Large Cap Value Fund in an interview.

 AJO has $26 billion in client assets under management, including $17 billion that is managed in precisely the same way as the BPV Large Cap Value Fund, according to Aronson. The firm calls that strategy “large-cap absolute value.”

The goal of AJO’s value strategy is to outperform the Russell 1000 Value Index /zigman2/quotes/210598148/delayed RLV +1.05%  by using quantitative methods to select stocks, while also using sophisticated quantitative analysis to hold down expenses.

The Russell 1000 Value Index is a subset of the Russell 1000 Large-Cap Index. It included 684 companies as of June 30, “with lower price-to-book ratios and lower expected growth values,” according to Russell Indexes .

“Historically we have done about 3 percentage points better” than the index, Aronson said when discussing the long-term performance of AJO’s value strategy. He said those gains have been “a bit on the generous side. I think we can do 2%.”

Annual returns averaging 2 percentage points higher than the index can lead to major outperformance over time.


FactSet
Since its inception on March 31, 2014, the BPV Large Cap Value Fund has come out ahead of the Russell 1000 Value Index.

Since the BPV Large Cap Value Fund’s inception on March 31, 2014, its total return has been 9.97%, beating the Russell 1000 Value Index’s 9.56%. Of course, topping the index for such a short period doesn’t mean much.

/zigman2/quotes/205061618/realtime
US : U.S.: Nasdaq
$ 45.52
-0.31 -0.68%
Volume: 0.00
Aug. 7, 2020
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/zigman2/quotes/200918620/realtime
US : U.S.: Nasdaq
$ 53.76
+0.24 +0.45%
Volume: 0.00
Aug. 7, 2020
loading...
/zigman2/quotes/210599714/realtime
US : S&P US
3,351.28
+2.12 +0.06%
Volume: 2.28B
Aug. 7, 2020 5:10p
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/zigman2/quotes/205061618/realtime
US : U.S.: Nasdaq
$ 45.52
-0.31 -0.68%
Volume: 0.00
Aug. 7, 2020
loading...
/zigman2/quotes/200918620/realtime
US : U.S.: Nasdaq
$ 53.76
+0.24 +0.45%
Volume: 0.00
Aug. 7, 2020
loading...
/zigman2/quotes/210599714/realtime
US : S&P US
3,351.28
+2.12 +0.06%
Volume: 2.28B
Aug. 7, 2020 5:10p
loading...
/zigman2/quotes/210598148/delayed
US : US Composite
1,185.54
+12.36 +1.05%
Volume: 0.00
Aug. 7, 2020 7:11p
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