Over the 32 year period studied by Wermers and his co-authors, from 1975 to 2006, only 0.6% of funds delivered positive alpha through skill, as opposed to luck alone. The FDR cannot determine which funds delivered alpha through skill; it can only estimate the size of this group. Those select few funds (approximately 12 out of the 2,076 studied) will remain anonymous.
Of the remaining funds, 24.0% are unskilled and 75.4% are zero alpha (delivering excess returns sufficient to only cover fees and expenses).
A very interesting finding is that the proportion of skilled managers decreases over time, specifically from 1990 to 2006. In 1990, 14.4% of funds fell into the “skilled” category, while 9.2% were in the unskilled category. These numbers were 24.0% and 0.6%, respectively, in 2006. As the study notes, “although the number of actively managed funds has dramatically increased, skilled managers (those capable of picking stocks well enough to overcome their trading costs and expenses) have become increasingly rare.” The decay in alpha is shown in the graph below:
Funds were categorized into three investment objectives: Growth, Growth & Income, and Aggressive Growth. Wermers noted that this categorization was the only one consistently available for the 32 year time period he and his coauthors studied. The funds in the Aggressive Growth category exhibited the greatest degree of skill. These funds tilt toward small cap, low book-to-market, and momentum stocks. The Growth & Income category, which includes traditional value and core funds, had no funds that exhibited skill, along with a substantial portion that were unskilled, a finding that the study terms “remarkable.”
Another curious finding concerns the relationship between skill and fund size. In general, larger funds were more prevalent in the high alpha “right tail” of the data. We asked Wermers about this, since intuition would suggest that smaller “boutique” funds would exhibit greater skill, and that skill would erode as fund size grows and managers are forced to invest in a smaller universe of stocks. Wermers believes that these findings are inconclusive, though, since the vast majority of right-tail funds are there by luck alone—a more detailed examination of the funds within the right and left tails is underway.
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