Identifying the best active funds

The debate over whether actively managed mutual funds are superior to indexed strategies is probably as old as the first mutual fund. But time, combined with mountains of performance data and more creative ways to slice and analyze the data, has enabled what would seem like a cut-and-dried math problem to live on in perpetuity. Last year, for example, the average actively managed large-cap growth fund declined by 32 basis points (after fees), while the benchmark S&P 500 Index gained 1.4%. The fact that two-thirds of large-cap growth funds didn't beat the index strengthens the argument for just sitting in an index fund. Investors and financial advisers certainly have been speaking with their feet, driving a decade-long trend of assets moving out of actively managed funds and into passive indexed strategies. But even as index funds gain appeal as relatively safe beta plays on a market that has been chugging along nicely since the financial crisis, there remains the allure of potentially beating the index, which some funds clearly do. Of course, identifying which funds are likely to beat their benchmarks is where the challenge begins, and where financial advisers can earn their keep. Along those lines, American Funds has done some data crunching and found that success in beating an index often comes down to two simple factors. As InvestmentNews senior columnist Jeff Benjamin reports, screening active funds for low fees and high portfolio manager ownership in the fund can go a long way toward identifying winners.

PURE DRAG

The fee issue is somewhat intuitive and probably already among the screens most advisers apply when selecting funds for clients. The average large-cap equity fund has an expense ratio of 1.1%, which represents pure drag when competing with an index. American Funds, as the largest actively managed fund complex with $1.4 trillion under management, clearly has a dog in the fight. (As does Fidelity Investments, which also updated its research on active management last week, showing that low fees combined with the backing of a large asset management firm can produce superior returns.) But the research is sound when viewed in one-year rolling periods over multiple years.The matter of managers investing in their own funds is the factor that seals the deal, and advisers would be wise to make that part of regular fund screening.