Does JPMorgan Chase Add Value For Investors?

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1 Does JPMorgan Chase Add Value For Investors? June 2, 2015 by Larry Swedroe In an April column, New York Times reporter Nathaniel Popper noted that, over the last few years, an expanding line of mutual funds created by large commercial banks has attracted billions of dollars from investors looking to earn a good return. But have those actively managed mutual funds been good investment choices? In the previous installment of my series, which systematically evaluates the results posted by some of the market s foremost fund families, I examined the performance of funds managed by Goldman Sachs Asset Management. Today, I ll take an in-depth look at the mutual funds offered by another commercial bank, JPMorgan Chase. In his article, Popper observed that, over the last 10 years, Morningstar data shows just 31% of JPMorgan Chase s mutual funds were able to outperform their analyst-assigned benchmarks. Despite this underperformance, JP Morgan Chase asserts that its investment engines provide more diversified return sources and the potential for positive results even in challenging markets. The firm explains that a research-driven information advantage provides investors with a growing network of career research analysts focused entirely on studying their industries and companies. They add: An unrelenting focus on risk management offers a consistent, repeatable approach across unpredictable markets, backed by standardized investment practices and research platforms. Furthermore, the firm states that it has 900 investment professionals in 23 countries, of which more than 340 are career analysts averaging 15 years of experience. Certainly, JPMorgan Chase has been successful at gathering assets. It is the eighth largest U.S. mutual fund company, and it has $1.7 trillion in assets under management across the globe. According to Morningstar, as of April 30, 2015, J.P. Morgan Asset Management had more than $318 billion in assets under management in mutual funds. But the question remains: Have their funds been adding value for investors, or has the firm itself been the real beneficiary? Active versus passive Page 1, 2018 Advisor Perspectives, Inc. All rights reserved.

2 As is my practice, I will compare the performance of JPMorgan Chase s actively managed equity funds to similar offerings from two prominent providers of passively managed funds, Dimensional Fund Advisors (DFA) and Vanguard. (Full disclosure: My firm, Buckingham, recommends DFA funds in constructing client portfolios.) To both keep the list to a manageable number of funds, as well as to make sure we examine long-term results through full economic cycles, I ll cover the 15-year period from April 2000 through March I ll use the lowest cost shares when more than one class of fund is available for the full period. In cases where JPMorgan Chase has more than one fund in the asset class, I ll use the average return of their funds in the comparison. The table below shows the performance of 22 of JPMorgan Chase s mutual funds (16 domestic and six international) in 12 asset classes. Page 2, 2018 Advisor Perspectives, Inc. All rights reserved.

3 Fund Symbol Annualized Return (%) Expense Ratio (%) U.S. Large-Cap Blend JPMorgan US Equity JMUEX JPMorgan Disciplined Equity JPIEX JPMorgan Growth & Income VGIIX JPMorgan Average DFA US Large Company DFUSX Vanguard Institutional Index VIIIX U.S. Large-Cap Growth JPMorgan Large Cap Growth Select SEEGX JPMorgan Growth Advantage VHIAX JPMorgan Average Vanguard Growth Index VIGIX U.S. Large-Cap Value JPMorgan Equity Income Select HLIEX JPMorgan Large Cap Value Select HLQVX JPMorgan Average DFA US Large Cap Value III DFUVX Vanguard Value Index VIVIX Page 3, 2018 Advisor Perspectives, Inc. All rights reserved.

4 U.S. Mid-Cap Blend JPMorgan Intrepid Mid Cap Select WOOPX Vanguard Mid Cap Index VMCIX U.S. Small-Cap Blend JPMorgan US Small Company JUSSX JPMorgan Small Cap Equity Select VSEIX JPMorgan Small Cap Core Select VSSCX JPMorgan Average DFA US Small Cap I DFSTX Vanguard Small Cap Index VSCIX U.S. Small-Cap Growth JPMorgan Dynamic Small Cap Growth Select JDSCX JPMorgan Small Cap Growth Select OGGFX JPMorgan Average Vanguard Small Cap Growth Index VISGX U.S. Small-Cap Value JPMorgan Small Cap Value Select PSOPX Undiscovered Managers Behavioral Value UBVLX Page 4, 2018 Advisor Perspectives, Inc. All rights reserved.

5 JPMorgan Average DFA US Small Cap Value I DFSTX Vanguard Small Cap Value VSIIX U.S. Real Estate JPMorgan Realty Income WOOPX DFA Real Estate Securities DFREX Vanguard REIT Index VGSIX International Large-Cap Blend JPMorgan International Opportunity JPIOX JPMorgan Int l Research Enhanced Equity Select OIEAX JPMorgan International Equity Select VSEIX JPMorgan Average DFA Large Cap International DFALX Vanguard Developed Markets Index VTMGX International Large-Cap Value JPMorgan International Value JNUSX DFA International Value III DFVIX Page 5, 2018 Advisor Perspectives, Inc. All rights reserved.

6 European Large-Cap Blend JPMorgan Intrepid European VEUAX Vanguard European Stock Index VEURX Emerging Markets JPMorgan Emerging Markets Equity JMIEX DFA Emerging Markets DFEMX Vanguard Emerging Markets Stock Index VEIEX The following is a synopsis of the most important takeaways from the data in the table above: Of the eight asset classes for which there are comparable DFA funds, the JPMorgan Chase funds provided a higher return in three of them. In these three asset classes, the average outperformance was 0.4 percentage points. In the five asset classes in which the DFA funds outperformed, the average outperformance was much greater at 2.1 percentage points. This finding is consistent with prior research showing that when active management outperforms, that outperformance tends to be relatively small. Conversely, when active management underperforms, the gap tends to be wider. In the 11 asset classes for which there are comparable Vanguard funds, the JPMorgan Chase funds provided a higher return in five, and there was one tie. In the five asset classes in which JPMorgan Chase funds outperformed, the average outperformance was 0.8 percentage points. In the five in which JPMorgan Chase underperformed, the average underperformance was 1.2 percentage points. In the eight asset classes where comparable DFA funds were available, an equal-weighted portfolio of JPMorgan Chase funds returned 7.0% a year. The average expense ratio was 0.89%. An equal-weighted DFA portfolio (in the same asset classes) returned 7.9% a year, outperforming the comparable JPMorgan Chase portfolio by 0.9 percentage points a year. The average expense ratio of the DFA portfolio of funds was 0.30%. The underperformance of the JPMorgan Chase funds isn t fully explained by the difference in the average expense ratios of the funds (0.59 percentage points). In supposedly inefficient asset classes, specifically U.S. small and emerging markets, JPMorgan Chase s funds underperformed. In the 11 asset classes where comparable Vanguard funds were available, an equal-weighted portfolio of JPMorgan Chase funds returned 6.8% a year. The average expense ratio was 0.98%. An equal-weighted Vanguard portfolio (in the same asset classes) returned 6.9% a year. The Page 6, 2018 Advisor Perspectives, Inc. All rights reserved.

7 average expense ratio for the Vanguard portfolio was 0.14%. In this case, the higher expenses (0.84%) of JPMorgan Chase s funds were greater than the difference in returns. Factor analysis We ll now take another look at the performance of JPMorgan Chase s funds using the analytical tools and data available at Portfolio Visualizer. The table below presents the results from a three-factor (beta, size and value), four-factor (adding momentum) and six-factor (adding quality and low beta) analysis of the firm s domestic funds (excluding its real estate fund). The data covers the same 15-year period from April 2000 through March The t-stats are in parentheses. Page 7, 2018 Advisor Perspectives, Inc. All rights reserved.

8 Fund Symbol Three- Factor Annual Alpha (%) Four- Factor Annual Alpha (%) Six- Factor Annual Alpha (%) JPMorgan US Equity JMUEX 1.27 (2.0) JPMorgan Disciplined Equity JPIEX 0.30 (0.5) JPMorgan Growth & Income VGIIX 0.20 (0.2) JPMorgan Large Cap Growth Select SEEGX 0.34 (0.3) JPMorgan Growth Advantage VHIAX (-0.7) JPMorgan Equity Income Select HLIEX 2.37 (2.3) JPMorgan Large Cap Value Select HLQVX (-0.4) JPMorgan Intrepid Mid Cap Select WOOPX 1.78 (1.3) JPMorgan US Small Company JUSSX (-2.1) JPMorgan Small Cap Equity Select VSEIX 3.74 (2.2) JPMorgan Small Cap Core Select VSSCX (-0.1) JPMorgan Small Cap Value Select PSOPX 2.31 (1.5) Undiscovered Managers Behavioral Value UBVLX 1.29 (0.7) 1.60 (2.7) 0.57 (1.1) 0.46 (0.6) 0.12 (0.1) (-1.7) 2.50 (2.4) 0.04 (0.0) 1.38 (1.0) (-1.1) 2.84 (1.9) (-0.7) 2.40 (1.5) 1.67 (0.9) 1.05 (1.7) (-0.6) (-1.5) (-0.5) 2.54 (1.3) 0.00 (0.0) (-1.6) 0.12 (0.1) (-1.3) 0.88 (0.6) (-2.2) (-0.9) 1.71 (0.8) Page 8, 2018 Advisor Perspectives, Inc. All rights reserved.

9 JPMorgan Dynamic Small Cap Growth Select JDSCX (-0.7) (-1.3) (-2.3) JPMorgan Small Cap Growth Select OGGFX 0.70 (0.3) (-1.0) (-1.2) Average When we examine the results from the three-factor analysis, we find that 10 of the 15 JPMorgan Chase funds generated positive annual alphas, though only three were statistically significant at the 5% level. The average annual alpha was 0.50%. When we look at the results from the four-factor analysis, we also find that 10 of the 15 JPMorgan Chase funds generated positive annual alphas, though only two were statistically significant at the 5% level. The average annual alpha was 0.15%. When we include all six factors, we find that just five of the 15 JPMorgan Chase funds generated positive annual alphas, though none were statistically significant at the 5% level. Two of the funds with negative alphas, however, were statistically significant. The average annual alpha was -0.76%. There are two additional important points to consider. First, all of the above data is based on pre-tax results. For investors holding these funds in taxable accounts, JPMorgan Chase s active management very likely would have produced more negative tax consequences than the passively managed alternatives of either DFA or Vanguard. Second, Morningstar data unfortunately contains survivorship bias. Thus, it s possible there were JPMorgan Chase funds that had performed poorly in the past and were either merged into better performing funds or closed. In this particular instance, we know that this is the case and that the data is biased. The data excludes the Undiscovered Managers Behavioral Growth Fund, which was closed in October 2012 (JPMorgan Chase acquired the company in 2003). It s rare, if unheard of, that a fund closes when it has produced good returns. While I don t have the returns of the Undiscovered Managers Behavioral Growth Fund through its close, I did write about it in early I found that for the 10-year period from 2000 through 2009, the fund returned -2.0% per year. That s compared to a 5.7% per year return of the DFA Small Cap Fund (DFSTX). That s an underperformance of 7.7 percentage points a year. Clearly, with an average expense ratio of close to 1%, the growth in mutual fund assets under management has been very good for JPMorgan Chase s bottom line. Unfortunately, the news wasn t good for investors in its funds. JPMorgan Chase didn t add value relative to the performance of either the DFA or Vanguard alternatives. And that s before considering the important issues of survivorship bias and, for taxable investors, taxes. In terms of the factor analysis, there wasn t much, if any, evidence that JPMorgan Page 9, 2018 Advisor Perspectives, Inc. All rights reserved.

10 Chase s fund managers persistently exploited market inefficiencies. Given the evidence of JPMorgan Chase s funds poor performance, it s worth noting that Bloomberg recently reported the firm had received subpoenas and inquiries from the Securities and Exchange Commission (SEC) and other regulators about how it sells its own mutual funds and other proprietary products. The SEC s enforcement division has been looking into whether the bank and its brokerage affiliate adopted a strategy that uses bonuses and other incentives to encourage their financial advisors to steer clients improperly into in-house funds, structured notes and other investments that generate fees. The probe includes a review of pensions and other accounts that hold the bank to a fiduciary standard of care, which obligates it to put clients' financial interests ahead of its own. JP Morgan Chase s funds have benefitted its bottom line, but not those of investors. The SEC may reveal part of the problem, but the central issue is the difficulty of a portfolio of actively managed funds whether run by a commercial bank or by any other institution have in beating a portfolio of diversified passive funds. Larry Swedroe is director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country. Page 10, 2018 Advisor Perspectives, Inc. All rights reserved.