Manager Churn Belies a Fundamental Truth

by Kyle Woodley | June 13, 2013 11:48 am

If the past 18 months are any indication, BlackRock’s (BLK[1]) funds division must be inspired by the late, great George Steinbrenner.

The company has replaced 80% of its active equity management teams[2] during that time frame — a merry-go-round personnel strategy that would make even the former Yankees owner blush.

Funny thing is, BLK’s renewed dedication to improving the quality of its actively managed funds really just serves to further bolster the case for good ol’ index funds.

BlackRock’s rapid-fire pink slips have been sparked by abysmal performance. As reported by Pensions & Investments, “Some 32% of the strategies underperformed for the year ended March 31, 39% for the three-year period and 43% for the five years, BlackRock data show.”

A good for-instance of long-term underperformance can be found in one of the company’s most basic actively managed mutual funds, the BlackRock Basic Value Fund (MDBAX[3]).

Fund 1-Year 3-Year 5-Year 10-Year
MDBAX (at NAV) 16.63% 9.97% 3.98% 7.91%
MDBAX (w/sales charge) 10.51% 8.01% 2.86% 7.33%
Russell 1000 Value Index 21.80% 2.35% 4.17% 8.42%
Note: BlackRock-provided figures are as of 4/30/13. Annual returns for 3-year, 5-year and 10-year.

MDBAX is one of those funds with new blood at the top. BlackRock tells us in the fund’s commentary section that the new fund manager (management is listed as Bart Geer and Carrie King) in the most recent quarter “continued to build weightings in the consumer discretionary and financials sectors.”

One almost has to feel bad for all of those displaced BlackRock fund managers, though. After all, they were merely upholding the actively managed status quo.

According to Standard & Poor’s 10th annual fund performance scorecard, roughly 84% of actively managed U.S. stock funds underperformed[4] vs. S&P indices best representing their benchmarks.

Kinda makes that 80% cleaving look … right on target.

It’s that underperformance — helped in part by the traditionally lower fees of indexed funds — that makes indexed investing so much more appealing, be it via mutual funds or exchange-traded funds.*

For instance, also in the value category — and also issued by BlackRock via its iShares division — is the iShares Russell 1000 Value ETF (IWD[5]), which tracks the Russell 1000 (the same index that serves as MDBAX’s performance benchmark). IWD not only is much cheaper at 0.18% in expenses than MDBAX (0.86% in expenses and a maximum 5.25 sales charge), but has performed better than Basic Value in the short- and long-term.

Fund 1-Year 3-Year 5-Year 10-Year
MDBAX (w/sales charge) 10.51% 8.01% 2.86% 7.33%
IWD 18.52% 12.53% 4.72% 9.02%
Russell 1000 Value Index 21.80% 12.35% 4.17% 8.42%
Note: BlackRock-provided MDBAX and Russell 1000 returns are as of 4/30/13, whereas IWD figures are as of
3/31/13. While that skews the performance somewhat, it’s not by much; it still holds that IWD greatly
outperforms the MDBAX and more closely tracks the performance benchmark … as it should.

Needless to say, BlackRock has a good case when it says it wants to improve performance in these actively managed funds.

And why shouldn’t it? They’re a cash cow! According to PIonline, despite the fact that active equity funds account for just 7% of BlackRock’s $3.9 trillion in AUM, their revenues were 20.3% of the fees the firm collected in Q1.

But new managers shouldn’t spur investors back into the arms of BlackRock’s actively managed funds anytime soon. In addition to the ugly numbers for all active management (broad underperformance has been the norm for years), you have to wonder how the threat of BLK’s bloody scythe will affect current mangers, new or not. BlackRock made it abundantly clear that its managers are essentially under constant performance surveillance, and that even three years is plenty of time to start ringing alarm bells.

If you think the pink slip of Damocles won’t be enough cause for some panicked moves to juice performance, I’ve got a bridge on the market that’s right for you.

All of this isn’t to say that actively managed funds should be explicitly verboten in your investment strategy. Some managers outperform, and have for a long time, or they provide certain fund strategies that you can’t just tether to an index. Those managers earn their keep.

But for the most part, if you can get the flavors you want via an index, odds are heavily in your favor that it’ll be the better option … and cheaper to boot.

*There’s a common misperception that all mutual funds are actively managed and all ETFs are passively managed (index-tracking). That’s untrue. There are several indexed mutual funds that offer a much cheaper investment opportunity than their similarly styled actively managed brethren.

Kyle Woodley[6] is the Deputy Managing Editor of InvestorPlace.com[7]. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @IPKyleWoodley[8].

Endnotes:
  1. BLK: http://studio-5.financialcontent.com/investplace/quote?Symbol=BLK
  2. replaced 80% of its active equity management teams: http://www.pionline.com/article/20130610/PRINTSUB/306109981
  3. MDBAX: http://studio-5.financialcontent.com/investplace/quote?Symbol=MDBAX
  4. roughly 84% of actively managed U.S. stock funds underperformed: http://investorplace.com/2012/03/actively-managed-mutual-funds-underperform/
  5. IWD: http://studio-5.financialcontent.com/investplace/quote?Symbol=IWD
  6. Kyle Woodley: http://www.investorplace.com/author/kyle-woodley/
  7. InvestorPlace.com: http://investorplace.com
  8. @IPKyleWoodley: https://twitter.com/#%21/ipkylewoodley

Source URL: http://investorplace.com/2013/06/manager-churn-belies-a-fundamental-truth/
Short URL: http://invstplc.com/1nrUS3o