Lipper recently gave financial services firm TIAA-CREF the award for “Best Overall Large Fund Company,” making 2015 the first time any fund family has won this honor for three consecutive years. Among its actively managed peers, TIAA-CREF’s funds did exceptionally well. But does that mean your clients benefitted by owning its funds?
By way of background, The Lipper Award is given to the fund family with the lowest average decile ranking over the most recent three calendar years. On its website, TIAA-CREF proclaimed: “This is a historic achievement for a global asset management powerhouse. It reflects the consistency of our risk-adjusted returns and how we strive to deliver better investment outcomes for your clients.” They went on to add: “TIAA-CREF is a global asset manager that oversees more than $600 billion worldwide across multiple asset classes and strategies. Our 300 investment professionals have deep experience managing money through all market cycles and are focused on delivering consistent performance to help your clients work toward their goals.”
TIAA-CREF’s award-winning performance makes it a good candidate for my continuing series examining the ability of actively managed mutual fund families to add value. Using Morningstar data, I will compare the returns of funds managed by TIAA-CREF to passively managed funds of the same asset class. I will use two of the largest providers of passively managed alternatives – Dimensional Fund Advisors (DFA) and Vanguard. (Full disclosure: My firm, Buckingham, recommends DFA funds in constructing client portfolios.)
The data covers the 10-year period ending March 31, 2015. For Vanguard and DFA funds, I’ll use the lowest-cost share class available. In addition to their regular share classes, TIAA-CREF has institutional share classes. Their expense ratios are 0.25 percentage points lower than those of the regular share classes. Because the institutional share classes may not be available to most investors, the following table shows the results using the regular share class of each fund. As you review the data, keep in mind that we have the benefit of hindsight. Based on the award, we know today that TIAA-CREF had some of the best returns of any large fund family over the past three years.
There are two points worth noting. First, TRGIX is a large-growth fund, and the closest matches to it from Vanguard and DFA are their large-blend funds. Historically, the S&P 500 Index has outperformed large-growth stocks. But during the period from April 2005 through February 2015 (we don’t have the Fama-French data for March 2015, the last month in the 10-year period) large-growth stocks outperformed the S&P 500 by 1.6 percentage points a year (9.9% versus 8.3%).
In other words, while the TIAA-CREF large-growth fund did indeed outperform the Vanguard and DFA index funds, it’s likely that it would not have outperformed a large-growth index fund, at least not by the wide margin we see in the table.
Second, the TIAA-CREF international fund includes exposure (currently about 10%) to emerging markets, while the Vanguard and DFA funds don’t.
From April 2005 through February 2015, the MSCI Emerging Markets Index outperformed the MSCI EAFE Index, which tracks developed markets, by 3.4 percentage points (9.1% versus 5.6%). Thus, the TIAA-CREF fund benefited from that exposure, and that likely fully explains the small outperformance we see in the table.
Even without taking the above considerations into account, the TIAA-CREF funds produced both lower returns and lower Sharpe ratios than the Vanguard and DFA funds in three of the five asset classes. And an equal-weighted portfolio of TIAA-CREF funds produced returns 0.4 percentage points lower than an equal-weighted portfolio of either Vanguard or DFA funds.
The TIAA-CREF funds did produce slightly lower volatility than the Vanguard and DFA funds and virtually identical Sharpe ratios to them as well. Even investors in the institutional share classes would have earned lower returns, as the 0.4 percentage point gap in returns is greater than the 0.25% lower expenses incurred by these shares.
Even with the benefit of hindsight – which allows us to know that TIAA-CREF won the Lipper award for the prior three years – there is no evidence of superior performance by this family of actively managed funds. When compared to either the Vanguard or DFA portfolios, the shortfall in returns was less than the difference in expense ratios.
On a gross basis, TIAA-CREF added value; on an after-fee basis, it did not. Unfortunately, investors only get to spend net returns.
This example is just another demonstration of why active management is a loser’s game. It’s not impossible to win, but the odds of doing so are so low it’s not prudent to try.
Larry Swedroe is director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country.
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