How’s that for objective?

Of course, in looking at this one would have to question why we are comparing all of the different flavors of these various types of domestic equity funds to the S&P500 when most of them don’t own it. Why not compare them to bonds or real estate, gold or oil? That would obviously be nuts, comparing apples to oranges as I (and many other readers commenting on Howard’s first “research” response to Wermers) pointed out, but he evaded in his response shifting to subjective peer groups for which he provided no evidence of skill. Howard failed to respond to my two basic criticisms of his choice of a large cap blend benchmark to grade all domestic equity funds. At the end of his article, he acknowledged that luck indeed exists, but ignored responding that the premise of his “research” showing an increasing “alpha slope” assumed that luck cannot exist and all out performance was therefore skill.  Instead, like many sailors before Columbus who thought the world was flat based on their limited visual horizon benchmark, Howard criticizes objective attempts to measure how much skill and how much luck as if it were data mining.

Howard is right, not all funds are, nor should be, compared to style boxes. His answer is “Focus on Strategy,” even though the evidence in his supposed research didn’t measure it that way and instead benchmarked it against the S&P500. This is a very interesting logical quandary. Howard states that skill is increasing because more and more funds have been beating the S&P500, or have been doing so to a greater extent. Then, he argues that we shouldn’t benchmark them against an index at all, but instead base it on something completely subjective, “Strategy Peer Groups.” He offers no measurements here to prove the increase in skill, and I think that I might know why.

Let’s lose the style boxes, as Howard argues we should, and let’s make the assumption that managers will demonstrate skill by security selection, style shifts, and market cap movements, freely among all reasonably tradable domestic equity securities. There is a large mish mosh of strategies being deployed amongst these managers. Presumably, Dr. Howard would accept these assumptions.  Let’s also assume that skill doesn’t necessarily evidence itself as higher returns and might also be represented by lower risk. Then, let’s take all those 5,745 funds of various domestic equity flavors from my initial response to Howard and compare them to a benchmark that is more similar to the securities they can choose from for their portfolios, like the Russell 3000 which represents 98% of the investable domestic equity market.

Why didn’t Howard use the Russell 3000 or Wilshire 5000 as his benchmark for his “alpha slope research” instead of the S&P500, which is only 75% of domestic equities by market capitalization? The only answer I could come up with is it didn’t show that the earth was flat. Looking beyond his large cap horizon and taking all domestic equity funds versus a benchmark of basically all domestic equities comes up with a different answer. That answer, of the 5,745 domestic “any” funds, only 47.33% had higher return and only 27.46% had less risk over the entire six years. In the first three years, 48.38% had higher returns and 36% had less risk. An increasing alpha slope indeed!

Howard‘s lack of attention to his critic’s fundamental questions impugns his credibility. I, along with others, identified that his regression alpha slope trend line demonstrated nothing other than large cap blend stocks are something that is easy or hard to beat at different times. He did not really materially respond to this assertion.

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