A look at a fund company’s attempt to defend active management

Earlier this month U.S. Global Investors posted a piece titled “A Face-Off Between Passive and Active Investing” defending their sector-specific actively managed funds by comparing their funds’ recent performance to a variety of ETFs.  You can read the full piece here: http://www.usfunds.com/investor-resources/investor-alert/a-face-off-between-passive-and-active-investing

The article is this fund company’s attempt to convince readers that active management is superior to a long term passive strategy.  However, the “study” presented is so full of holes no one doing an actual analysis of active vs. passive performance would take this seriously.

The first glaring problem is that none of the time frames examined is much longer than twelve months. A single year is not a sufficient time period to study a long term investment strategy.  Multiple rolling periods are necessary to minimize the impact of chance. Also, none of the figures presented are risk-adjusted.  In a volatile year in volatile markets, consideration of risk-adjusted returns needs to come well before any appropriate comparison can be made.

Next, let’s point out improper benchmark comparison.  US Global compares its Eastern Europe fund (EUROX) to a Russia-specific ETF (RSX).  The article states clearly that the fund has a broader mandate than the Russia ETF – so how can it be considered a comparable benchmark? This is the same as comparing a broad US stock fund to an ETF that specializes in companies domiciled in Colorado, or comparing global market returns to the S&P 500. Apples and oranges. Claiming that active management is superior because an active fund is more diversified simply means investors can look for more diversified passive strategies.

US Global points out that its natural resources strategy (USERX) outperformed the new iShares metals & mining ETF (PICK).  In a down market, the more diversified and less volatile active fund beat the highly concentrated ETF.  This is called BETA and is exactly what one should expect – a riskier (more concentrated) investment is going to be more volatile and lose more in a down market.  Again, the returns compared are not appropriately risk-adjusted.

The article ends with a comparison of active management to hockey great Wayne Gretzky, who in many years of playing won “only” four Stanley Cup championships.  This is a complete non-sequitur.  Stating that active management is a successful philosophy because a manager might occasionally beat the market does nothing to compare the long term results of active and passive investing.

Finally, one might also ask how the fund company arrived at these three comparisons when they offer 13 products.  We can’t be surprised to see that this “study” touts three funds that beat a benchmark (whether the benchmark is appropriate or not).  As a quick example, we can look at the same company’s China fund gained +2.21% over the twelve months ending 11/30/2012 (here: http://www.usfunds.com/our-funds/our-mutual-funds/china-region-fund/performance/#.UNKSZm_BGyU), compared to the iShares MSCI China ETF (chosen at random from several Chinese market ETF options), which gained +16.69% over the same period (here: http://us.ishares.com/product_info/fund/performance/MCHI.htm). US Global’s Emerging Markets fund has similar drastic underperformance relative to a broad emerging markets ETF such as EEM or VWO.  Funny, you don’t see those comparisons in this “study.”

Let’s call this article from US Global what it is: carefully crafted marketing masquerading as data worthy of consideration, and an attempt to mislead investors to believing that active management can and does regularly outperform a low-cost passive strategy.

Of course, my post is not a true study either.  The studies have been done, and continue to be done.  Today the real leader in up-to-date passive/active data is S&P’s SPIVA study which is updated twice a year and regularly shows the majority of mutual funds missing their respective benchmarks. The academic studies and current data are unchanged in proving that the majority of active management is doomed to failure and costs are the primary driver of investment success.