Did Barron s Number-One Ranked Fund Family Add Value for Its Investors?
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1 Did Barron s Number-One Ranked Fund Family Add Value for Its Investors? August 11, 2015 by Larry Swedroe Our series evaluating the performance of the market s most prominent actively managed mutual fund firms continues today with an in-depth look at Waddell & Reed Investment Management, which in February earned a number-one spot on Barron s list 1 of best fund families for the prior 10-year period. In its annual ranking, Barron s named Waddell & Reed the top-performing mutual fund family (out of 48) for the preceding 10-year period. In the latest five-year period, the firm ranked second (out of 56 fund families). Waddell & Reed, however, dropped all the way to 50th place (out of 65 fund families) in the one-year rankings based on the firm s performance in In response to his firm s rank on the list, Waddell & Reed s chairman and CEO, Henry Herrmann, stated: Over longer periods, and across differing market cycles, our rigorous investment process has led to solid results for investors. We prefer to judge performance across several years, as the majority of our investors have long-term goals and aspirations. We re pleased to see that these rankings have continued to validate our process. By examining Waddell & Reed next, I am injecting a large degree of hindsight bias into the picture. There is no way to have known 10 years ago that Waddell & Reed would earn a number-one ranking. After all, if any actively managed fund family were able to deliver superior results, surely it would be the one chosen by Barron s as its top performer during the last decade. Thus, we clearly should expect to see Waddell & Reed s funds outperform relative to passively managed alternatives. As is my practice, I ll begin my analysis by comparing the performance of Waddell & Reed s actively managed domestic 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.) Morningstar reported that as of the end of May 2015, Waddell & Reed had almost $29 billion in assets under management. While I usually employ 15-year periods in performing this analysis, in this case I ve chosen to limit the period to 10 years because there were only five Waddell & Reed funds in two asset classes with a 15- Page 1, 2018 Advisor Perspectives, Inc. All rights reserved.
2 year track record. Limiting my analysis to just five funds would reduce the comparison s value. Even limiting my period to 10 years leaves me with just seven funds covering four domestic asset classes. The period I examine runs from June 2005 through May 2015, differing slightly from the 10-year period covered by Barron s. In cases where Waddell & Reed has more than one fund in an asset class, I ll use the average return of their funds in the comparison. I ll use the lowest-cost shares when more than one class of fund is available for the full period. This is particularly important to note in this instance because Morningstar reports that almost 97% of Waddell & Reed s assets under management are in funds that have loads (and thus carry higher expenses). June 2005-May 2015 Page 2, 2018 Advisor Perspectives, Inc. All rights reserved.
3 Fund Symbol Annualized Return Expense Ratio U.S. Large-Cap Blend s Dividend Opportunities WDVYX DFA U.S. Large Company DFUSX Vanguard 500 Index VFIAX U.S. Large-Cap Growth Accumulative WAAYX Core Investment UNIYX Tax Managed Equity WTEAX Vanguard WAVYX Waddell & Reed Average Vanguard Growth Index VIGIX U.S. Large-Cap Value Value WVAYX DFA U.S. Large Cap Value III DFUVX Vanguard Value Index VIVIX U.S. Small-Cap Growth Page 3, 2018 Advisor Perspectives, Inc. All rights reserved.
4 Small Cap WRSYX Vanguard Small Cap Index VSCIX The following are the most important takeaways from of the data in the above table: In both of the asset classes for which there are comparable DFA funds, the Waddell & Reed funds underperformed their passive counterparts. In the four asset classes for which there are comparable Vanguard funds, the Waddell & Reed funds provided a higher return in two of them. In the pair of asset classes for which Waddell & Reed funds outperformed their passive counterparts, they did so by the slimmest of margins, 0.1 percentage points and 0.2 percentage points. In the two asset classes for which the firm underperformed, that underperformance was a bit wider at 0.3 percentage points and 0.4 percentage points. A portfolio of Waddell & Reed funds, equal-weighted in the asset classes for which there are comparable DFA funds, returned 7.7% a year. The average expense ratio of funds in that portfolio was 0.93%. An equally weighted portfolio of DFA funds in the same asset classes returned 8.3% a year, outperforming the comparable Waddell & Reed portfolio by 0.6 percentage points a year. The average expense ratio of funds in the DFA portfolio was 0.11%. The underperformance of the Waddell & Reed funds was more than fully explained by the difference (0.82 percentage points) in the expense ratios of the funds. In the four asset classes for which comparable Vanguard funds were available, an equalweighted portfolio of Waddell & Reed funds returned 8.8% a year. The average expense ratio of funds used for that portfolio was 0.96%. An equally weighted portfolio of Vanguard funds in the same asset classes returned 8.9% a year, outperforming slightly. The average expense ratio of the funds in the Vanguard portfolio was 0.07%. The underperformance of the Waddell & Reed funds was more than fully explained by the difference (0.89 percentage points) in the expense ratios of the funds. In the supposedly inefficient asset class of U.S. small stocks, where active management should be able to add value, the Waddell & Reed fund managed to underperform its passive alternatives. The bottom line is that the Waddell & Reed funds underperformed the DFA funds, and in the case of Vanguard, it was a virtual tie. Given the huge disparity in Waddell & Reed s expense ratios versus DFA/Vanguard, these results could be viewed as quite an accomplishment and possibly provide evidence of stock-picking skills (before expenses). However, these results should also be viewed as a big surprise because Waddell & Reed was selected by Barron s as the single best-performing mutual fund family over the 10-year period it examined ( ). If the single best fund family didn t manage to outperform passive alternatives, that doesn t bode very well for investors in other actively managed fund families ranked lower. Factor analysis Page 4, 2018 Advisor Perspectives, Inc. All rights reserved.
5 I ll now take another, slightly different look at the performance of the seven Waddell & Reed funds included in the above table using the analytical tools and data available at Portfolio Visualizer. Factor analysis provides important additional insights into performance because Morningstar asset class categories are very broad and actively managed funds often style drift. The following table shows the results of the three-factor (beta, size and value), four-factor (adding momentum) and six-factor (adding quality and low-beta) analysis for the firm s domestic funds. Due to limitations in the data, the table covers the period from June 2005 through February The t-stats are in parentheses. June 2005-Febraury 2015 Fund Symbol Three-Factor Annual Alpha Four-Factor Annual Alpha Six-Factor Annual Alpha s Dividend Opportunities WDVYX -0.2 (-0.2) -0.5 (-0.4) 0.4 (0.3) Accumulative WAAYX -0.5 (-0.4) -0.6 (-0.6) -0.3 (-0.3) Core Investment UNIYX 1.7 (1.4) 1.5 (1.3) 2.1 (1.8) Tax Managed Equity WTEAX 1.2 (0.8) 1.0 (0.7) 1.6 (1.1) Vanguard WAVYX 0.5 (0.3) 0.2 (0.1) 1.0 (0.8) Value WVAYX 0.1 (0.1) 0.1 (0.1) -0.3 (-0.3) Small Cap WRSYX 1.3 (0.6) 0.8 (0.4) 0.9 (0.5) Average Page 5, 2018 Advisor Perspectives, Inc. All rights reserved.
6 When we examine the results from the three-factor analysis, we find that five of the seven Waddell & Reed funds generated positive annual alphas, although none were statistically significant at the 5% level. The average annual alpha was 0.6%. When we look at results from the four-factor analysis, we also find that five of the seven Waddell & Reed funds generated positive annual alphas, although again none were statistically significant at the 5% level. The average annual alpha was 0.4%. Third, when we include all six factors, we find that five of the seven funds generated positive annual alphas, although yet again none were statistically significant at the 5% level. The average annual alpha was 0.8%. Keep in mind that a fund can show alpha in the factor analysis but underperform a similar fund from the same broad asset class (even if the other fund had a lower alpha) because it had lower exposures to factors that had generated premiums (or higher exposures to factors with negative premiums). There are two more important points to consider. All of the above data is based on pre-tax results. For investors holding these funds in taxable accounts, the active management of Waddell & Reed funds very likely would have produced greater negative tax consequences than the passively managed alternatives from either DFA or Vanguard. Second, Morningstar data unfortunately contains survivorship bias, which would occur if Waddell & Reed had closed or merged any underperforming funds during this period. That may or may not exist in this case; I have no way of knowing. In short, it s very hard to make a case that the Waddell & Reed funds added value for investors, especially for taxable investors. This is quite a surprising result given that they were named the number-one mutual fund family over the 10-year period ending in And, of course, there was no way anyone could have known ahead of time that Waddell & Reed would earn that top ranking. There is one other insight I can add, at least in terms of the seven funds for which we do have comparisons. Even after fund expenses and considering trading costs, most of the Waddell & Reed fund managers appear to have demonstrated stock-picking skills. That shows up in the alphas from the factor analyses. Had Waddell & Reed funds been more Vanguard-like, or even more DFA-like, and charged lower expense ratios, they would have outperformed. The problem for investors is that more than 100% of the value added through stock-picking skill landed in the pockets of the fund sponsor or advisors who were being compensated for recommending the funds. Again, it s important to note that my analysis used the lowest-cost versions of the funds. Investors who paid higher fees fared that much worse. As a post-script, I also examined the performance of comparable Waddell & Reed funds for the 15- year period ending May Unfortunately, there were just five funds available in two asset classes. And the only comparable funds were from Vanguard. Here s a summary of the results: Waddell & Reed outperformed in the asset class of large growth. A portfolio of their funds returned 5.1% and outperformed the comparable Vanguard fund (which returned 3.9%) by 1.2 percentage points. In the asset class of small growth, the Waddell & Reed fund Page 6, 2018 Advisor Perspectives, Inc. All rights reserved.
7 returned 8.1% and underperformed the comparable Vanguard fund (which returned 9.3%) by the same 1.2 percentage point difference. Thus, we have a draw. Again, there is no evidence of Waddell & Reed s ability to add value after expenses, especially for taxable investors. Larry Swedroe is director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country. 1. Subscription required Page 7, 2018 Advisor Perspectives, Inc. All rights reserved.
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