Do The Russell Funds Add Value for Investors?

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1 Do The Russell Funds Add Value for Investors? November 2, 2015 by Larry Swedroe Do The Russell Funds Add Value for Investors? By Larry Swedroe November 3, 2015 My series evaluating the performance of the market s most prominent actively managed mutual fund families continues with an in-depth analysis of the Russell family of funds. Why Russell? It is a highly prominent provider of investment and pension fund consulting. Nonetheless, in February, the firm ranked last (out of 48) on Barron s annual list of best-performing mutual fund families for the latest 10-year period. For the latest five-year period, Russell was ranked 51st (out of 56 fund families). And in the one-year rankings, based on 2014 performance, the firm placed 54th (out of 65 fund families), though one-year performance should be treated as anecdotal in nature. Despite the poor performance, Morningstar reports that as of July 31, 2015, Russell had over $47 billion in assets under management in its mutual funds, an increase of about 10% from The impact of the firm s investor returns goes well beyond the $47 billion it has under management, as Russell is one of the largest players in the world of investment consulting. It provides investment consulting to pension plans and other institutional investors. It also offers advice on selecting the best active managers to investment advisors. In fact, its website proclaims: For the fifth year in a row, Russell was ranked as the largest manager of worldwide institutional outsourced assets out of 79 firms in the Pensions & Investments survey issued in July Russell s expanding investment outsourcing solutions has more than $117.3 billion in institutional outsourced assets around the globe. It also states: For the fourth year in a row, Russell was reported as the largest manager of institutional outsourced assets based on the AUM from its fully discretionary clients. It adds: In 2013, for the third year in a row, Russell was named as an aicio Industry Innovation Award winner. The 2013 award named Russell the winner in the Investment Outsourcing category for asset managers and servicers. Notably, Russell was recognized for its in-house implementation Page 1, 2018 Advisor Perspectives, Inc. All rights reserved.

2 capabilities and robust investment and sales teams. Finally, it proclaims: For the fifth year in a row, Russell was ranked as one of the top-five largest consultants. Ranking is based on worldwide assets under advisement (AUA) by the 2014 Pensions & Investments Consultant Directory. Given the assets Russell has under management and advisement, it s clear that its sales teams have done a great job. But what about the investment results? How has the performance of the Russell funds stacked up against the performance of comparable passively managed funds? Have its funds been generating alpha when judged against appropriate risk-adjusted benchmarks? I ll answer these questions in my analysis. I ll also see if the results achieve the firm s stated goals: We re a global asset manager with a unique set of capabilities essential to managing total portfolio solutions. Our goal? Increasing the probability that investors will reach their desired outcomes. To find the answers, I ll compare the performance of Russell 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 keep the list to a manageable number of funds and to ensure that I examine long-term results through full economic cycles, I will analyze the 15-year period ending June 30, Furthermore, I ll use the lowest-cost shares available for the full period when more than one class of fund is available. In cases where Russell has more than one fund in an asset class, I ll use the average return of those funds in our comparison. The table below shows the performance of seven funds offered by Russell in three domestic asset classes and two international asset classes. The funds are placed in the asset class based on Morningstar s investment style categorization. July June 2015 Page 2, 2018 Advisor Perspectives, Inc. All rights reserved.

3 Fund SymbolExpense Ratio Annualized Return U.S. Large-Cap Blend Russell U.S. Core Equity Fund REASX Russell U.S. Defensive Equity Fund REUYX Russell Tax-Managed U.S. Large Cap Fund RETSX Russell Average DFA U.S. Large Company Portfolio DFUSX Vanguard 500 Index Fund VFINX U.S. Small Blend Russell U.S. Small Cap Equity Fund REBYX DFA U.S. Small Cap Portfolio DFSTX Vanguard Small Cap Index Fund VSCIX U.S. Small-Cap Growth Russell Tax-Managed U.S. Mid & Small Cap Fund RTSSX Vanguard Small Cap Growth Index Fund VSGIX International Large Blend Russell International Developed Markets RINYX DFA Large Cap International Portfolio DFALX Vanguard Developed Markets Index Fund VTMGX Page 3, 2018 Advisor Perspectives, Inc. All rights reserved.

4 Emerging Markets Large Value Russell Emerging Markets REMSX DFA Emerging Markets Value I DFEVX The following are the most important takeaways from this data: In each of the four asset classes for which there are comparable DFA funds, the Russell funds failed to outperform. In two cases, the underperformance was by 0.4 percentage point and 0.5 percentage point, gaps that could be explained by the differences in expense ratios. In the other two cases, the underperformance was much greater than the expense ratio at 2.1 percentage points and 2.4 percentage points. In each of the four asset classes for which there are comparable funds from Vanguard, the Russell funds failed to outperform. In two cases, the underperformance was 0.3 percentage point and 0.4 percentage point, gaps that could be explained by the differences in expense ratios. In the other two cases, the underperformance was much greater at 1.3 percentage points and 2.3 percentage points. A portfolio of Russell funds, equal-weighted in the four asset classes for which there are comparable DFA funds returned 5.5% a year. The average expense ratio was 0.98%. An equalweighted portfolio of DFA funds, again in the same four asset classes, returned 6.9% a year and outperformed the comparable Russell portfolio by 1.4 percentage points a year. The DFA portfolio s average expense ratio was 0.32%. The underperformance of the Russell portfolio was well in excess of the difference (0.66 percentage points) in the average expense ratios. In the four asset classes for which comparable Vanguard funds are available, an equal-weighted portfolio of Russell funds returned 5.1% a year. The average expense ratio was 0.92%. An equalweighted portfolio of the Vanguard funds in the same four asset classes returned 6.2% a year and outperformed the comparable Russell portfolio by 1.1 percentage points a year. The Vanguard portfolio s average expense ratio was 0.11%. Again, the underperformance of the Russell portfolio was greater than the difference (0.81 percentage points) in the average expense ratios. Factor analysis I ll now take another look at the performance of the five domestic funds from Russell included above using the analytical tools and data available at Portfolio Visualizer. Factor analysis provides important additional insights because Morningstar asset class categories are very broad and actively managed funds often style drift. The table below shows the results of the three-factor (beta, size and value), four-factor (adding momentum) and six-factor (adding quality and low beta) analyses for the firm s U.S. funds. The data covers the period from July 2000 through June Each t-stat is in parentheses. July June 2015 Page 4, 2018 Advisor Perspectives, Inc. All rights reserved.

5 Fund Symbol Three-Factor Annual Alpha Four-Factor Annual Alpha Six-Factor Annual Alpha Russell U.S. Core Equity Fund -0.9 REASX (-2.0) -1.0 (-2.4) -1.4 (-3.3) Russell U.S. Defensive Equity Fund -2.4 REUYX (-2.3) -2.3 (-2.2) -3.7 (-3.4) Russell Tax-Managed U.S. Large Cap Fund -0.7 RETSX (-1.2) -0.5 (-0.8) -1.5 (-2.7) Russell U.S. Small Cap Equity Fund -6.1 REBYX (-2.1) -6.7 (-2.5) -9.8 (-3.2) Russell Tax-Managed U.S. Mid & Small Cap Fund -0.8 RTSSX (-0.6) -1.6 (-1.5) -1.6 (-1.4) Average Alpha When we examine the results from the three-factor analysis, we find that all five of the Russell funds generated negative alphas, with the average annual alpha being -2.2%. Four of the five funds showed statistically significant (at the 5% level) negative alphas. When we look at results from the four-factor analysis, we again find that all five of the Russell funds generated negative alphas. The average alpha was -2.4%. Three of the five funds showed statistically significant (at the 5% level) negative alphas. When we include all six factors in our analysis, the results get worse. Again, all five funds showed negative alphas, four of which were statistically significant at the five percent level, and three of which were statistically significant at the 1% level. The average annual alpha was -3.6%. This performance explains why the Russell family was ranked last by Barron s in the latest 10 calendar years. Whether one compares the results to passively managed funds in the same asset class or examines the results from the factor analysis, there is no evidence that, despite all the efforts and resources Russell expends, its investors were receiving added value. In fact, Russell was negatively affecting its Page 5, 2018 Advisor Perspectives, Inc. All rights reserved.

6 investors probabilities of achieving their goals. Investors would have been better served choosing lower-cost (and likely more tax efficient) passively managed alternatives. 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 the Russell funds very likely would have produced more negative tax consequences than the passively managed alternatives of either DFA or Vanguard. Turnover for the seven Russell funds analyzed averaged 78%, ranging from 63% to 105%. Second, Morningstar data unfortunately contains survivorship bias, which may or may not exist in this case. Some Russell funds may have been closed or merged into other funds during this time period because of poor performance. I have no way of knowing. Another conclusion we can draw is that the evidence presented supports the concept that, while it s possible to identify the fund managers who have outperformed in the past, it s much harder to do so ex-ante which is why the SEC requires its warning about relying on past performance. Reviewing results This was the 10th in my series reviewing the performance of some of the leading mutual fund families. Thus, I thought it a good time to review the findings from the 10 analyses performed to date. The table below shows the relative performance of the portfolios from each of the fund families relative to the performance of comparable portfolios from Vanguard and DFA, as well as the results of the factor analyses. In the case of TIAA-CREF, I did not originally perform the factor analysis. Thus, the data wasn t in the original article. However, I ve now added that data so that we have the same analysis for all 10 fund families. Page 6, 2018 Advisor Perspectives, Inc. All rights reserved.

7 Fund Family Portfolio Return Versus Vanguard Portfolio Return Versus DFA Three-Factor Average Alpha Four-Factor Average Alpha Six-Factor Average Alpha TIAA- CREF Goldman Sachs JPMorgan Chase American Funds Gabelli Funds Waddell & Reed John Hancock Morgan Stanley Wells Fargo Russell Average The following are the highlights from the table: Of the 10 actively managed fund family portfolios, just three outperformed the comparable Vanguard portfolios. The average for all 10 was an underperformance of 0.2%. Compared to the DFA portfolios, just one (American Funds) managed to outperform, and that was by the slimmest of margins, just 0.1%. The average underperformance was 0.7%. The three-factor regressions produced an average alpha for the 10 active fund families of just Page 7, 2018 Advisor Perspectives, Inc. All rights reserved.

8 0.1%. The four-factor regressions produced no alpha. And the six-factor regressions produced an alpha of -0.7%. The only actively managed fund family in the group that added value compared to both Vanguard and DFA (though by the smallest of margins in this case) was American Funds. American also showed positive alphas relative to each of the factor regressions. While the Waddell & Reed funds also showed positive alphas relative to each of the factor regressions, their funds underperformed comparable portfolios from both Vanguard (by the slimmest of margins) and DFA. Larry Swedroe is director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country. The included data and analysis is a summary of 10 other pieces related to an ongoing series evaluating actively managed mutual fund families. For a complete list of those pieces, click search Larry Swedroe at The corresponding portfolios are provided for informational purposes only, were constructed specifically for this review and are not portfolios that Buckingham recommends. The returns data included is from Morningstar, and Portfolio Visualizer ( provided the tool for the factor analysis. Performance is historical and does not guarantee future results. Information from sources deemed reliable but its accuracy cannot be guaranteed. It should not be assumed that any of the securities listed were or will prove to be profitable. Page 8, 2018 Advisor Perspectives, Inc. All rights reserved.