Busting the myth of manager diversification

Rick Ferri's firm finds that the more active funds held, the higher the underperformance

Jun 20, 2013 @ 3:43 pm

By Jason Kephart

Investing with multiple managers in a single asset class may seem like a good way to hedge against underperformance, but a new study shows that that actually may hurt returns.

Nine out of 10 portfolios that used three active managers per asset class over the 16-year period through 2012 failed to beat a comparable portfolio of index funds, according to a new research report by Portfolio Solutions LLC and Betterment LLC.

The study used 5,000 randomly created actively managed fund portfolios based on data from the CRSP Survivor-Bias-Free U.S. Mutual Fund database to calculate the performance.

Portfolios with just two actively managed funds did slightly better, as 13% beat a comparable portfolio of index funds.

Using just one actively managed fund per asset class gave a portfolio the best chance to outperform, though it still beat an all-index portfolio only 17% of the time.

“You're better off with one active fund and hoping for the best,” said Rick Ferri, founder of Portfolio Solutions. “The more active funds you have, the higher your probability of underperformance.”

The problem with the multiple-manager approach isn't just that the majority tend to underperform over any given time period but that the funds that do outperform don't do so by enough to offset the losses.

Of the 10% of funds that outperformed over the 16-year period, the median return was 0.29% above their respective index.

The median performance of the underperforming funds was 0.93% below the index, according to the study.

One way to boost performance was to stick with actively managed funds with below-average fees.

Portfolios made solely of those funds performed better on both the upside and downside than the general universe did.

The median outperformance of an actively managed fund portfolio with below-average fees was 0.33% and the median underperformance was 0.57%.

Still, it wasn't enough to tip the odds much. Those portfolios beat an all-index portfolio only 29% of the time, the study found.

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