The Mutual Fund Landscape - Part One
This study evaluates a sample of US funds totaling more than 5,200 managers and representing about $10 trillion in wealth by the end of 2014.
Surveying the landscape
Mutual funds are a popular way to invest, offering shareholders professional management and the convenience of daily pricing, market liquidity, periodic reporting, and access to many investment styles and strategies.
Exhibit 1.1 (below) offers a representative sample of the US mutual fund industry at the end of 2014, showing a category breakdown of US-domiciled equity and fixed income funds in operation. Exhibit 1.2 (below) graphs the total value
of assets under management by category for this sample over the past 15 years. Combined, the figures describe a large and growing industry. By the end of 2014, the sample contained more than 5,200 US-based funds collectively managing about $10 trillion in shareholder wealth. Since 2000, assets under management grew more than 213%, and the number of funds increased by 46%.
The sheer size of the mutual fund landscape highlights its importance as a primary vehicle to connect investors with the global financial markets, but also illustrates the challenge of fund evaluation and selection. Investors must choose among thousands of funds representing a broad range of manager philosophies, objectives, and styles—all of which contribute to fund performance and, ultimately, to the investor’s experience.
Exhibit 1.1 The US Mutual Fund Industry Number of equity and fixed income funds, 2014
In US dollars. Number of US-domiciled funds in the sample as of December 31, 2014. International equities include non-US developed and emerging markets funds. See Data appendix for more information. US-domiciled mutual fund data is from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago.
Exhibit 1.2 Assets under Management In USD (billions), 2000–2014
In US dollars. Past performance is no guarantee of future results. See Data appendix for more information. US-domiciled mutual fund data is from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago.
Despite a myriad of choices, selecting a successful fund manager is harder than it appears. The research shows that few mutual funds have delivered benchmark-beating returns over time. And although it is easy to find managers with impressive track records, past outperformance is rarely a reliable indicator of future performance.
The main reason is market competition. Each day, the global financial markets process millions of trades worth hundreds of billions of dollars. The buying and selling aggregates vast amounts of dispersed information into prices, driving them toward fair value.
This is good news for long-term investors. Though the price of a stock or bond may not always be perfect, investors can regard that price as the best estimate of actual value. But fair pricing works against fund managers and other market participants who believe they can identify “mispriced” securities and convert their knowledge into higher returns.
With the market’s pricing power at work, fund managers have few opportunities to gain an informational advantage, and most funds that search for mispriced securities face a steep uphill climb.
Let’s consider some of these challenges in more detail.
A case of disappearing funds
The size and complexity of the mutual fund landscape masks the fact that many funds disappear each year, often as a result of poor investment performance.
The gray boxes in Exhibits 2.1 and 2.2 (below) represent the number of US-domiciled equity and fixed income funds in operation during the past three, five, 10, and 15 years. These funds compose the beginning universe of each period. For example, an investor trying to select a mutual fund at the start of the three- year period (2012) could have chosen from 4,277 equity funds and 909 bond funds.
How many of the funds that began each period still existed at the end of 2014? The striped areas show the proportions that survived. During the three-year period, 85% of equity funds and 88% of fixed income funds survived. Over time, fund survival rates dropped sharply. In equities, the five-, 10-, and 15-year survival rates were just 75%, 56%, and 42%, respectively. The numbers were only slightly better in fixed income, with 79% of funds making it five years, 57% surviving 10 years, and 41% surviving 15 years.
Investors may be surprised by how many mutual funds become obsolete over time. Funds tend to disappear quietly, and underperforming funds—especially those that do not survive and are no longer available for investment—receive little attention.
Non-surviving funds tend to be poor performers. Certainly, investors would like to identify obsolete funds in advance and avoid them. But the reality is that everyone must choose from a universe that includes funds that will not survive the period, and an accurate depiction of the fund selection challenge requires performance data from both surviving and non-surviving funds.
Investors likely have a more ambitious goal than to just pick a fund that survives. Most people are on a hunt for funds that will outperform a benchmark. What were their chances of picking an outperforming, or “winning,” fund?
The blue and yellow areas show the proportion of equity and fixed income funds that outperformed their respective benchmarks. These funds are certainly in the minority. Over both short and longer time horizons—and for both equities and bonds—the deck is stacked against the investor seeking outperformance.
For example, only 31% of both equity and fixed income funds survived and outperformed their benchmarks for the three-year period ending December 31, 2014. Fund performance results are even worse over longer horizons. Less than one in four equity and fixed income funds survived to provide benchmark-beating performance over the five years through 2014. Over 15 years, the ratio dropped to one in five among equity funds and one in 12 among fixed income funds.
In the fiercely competitive mutual fund industry, many funds do not survive, but many more crop up to take their place. The free exit and entry supports a vast price discovery effort among managers, with the evidence suggesting reasonably fair market prices.
Exhibit 2.1 Survivorship and Outperformance—Equity Funds Performance periods ending December 31, 2014
Beginning sample includes funds as of the beginning of the three-, five-, 10-, and 15-year periods ending December 31, 2014. The number of beginners is indicated below the period label. Non-survivors include funds that were either liquidated or merged. Outperformers (winners) are funds that survived and beat their respective benchmarks over the period. Past performance is no guarantee of future results. See Data appendix for more information. US-domiciled mutual fund data is from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago.
Exhibit 2.2 Survivorship and Outperformance—Fixed Income Funds Performance periods ending December 31, 2014
Beginning sample includes funds as of the beginning of the three-, five-, 10-, and 15-year periods ending December 31, 2014. The number of beginners is indicated below the period label. Non-survivors include funds that were either liquidated or merged. Outperformers (winners) are funds that survived and beat their respective benchmarks over the period. Past performance is no guarantee of future results. See Data appendix for more information. US-domiciled mutual fund data is from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago.
Outperformance is hard to come by. Only 19% of equity funds and 8% of fixed income funds survived and outperformed over the 15-year period through 2014.