Intelligent Design

John McMillen | Portfolio Manager

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That Mutual Fund Ad May Be True, But Is It Accurate?

May 2010

Someone once said that the difference between unethical and ethical advertising is that unethical advertising uses falsehoods to deceive the public, while ethical advertising uses truth to deceive the public. Looking through all the mutual fund ads that run in the consumer press, it appears the investment industry has become expert in the latter.

With 45% of Americans investing in mutual funds, accounting for more than $9.6 trillion dollars, competition is fierce in the industry. Just about any newspaper or magazine will have advertisements like the one pictured below by Putnam Investments:

Covering two full pages in Investment News magazine, it was impossible for the reader to miss this ad and its clear message: Our managers are talented and experienced, and our funds have delivered exceptional performance.

While the ad is truthful, there is a larger truth that isn’t being communicated: For most of these funds, all this talent and experience has not translated into added value for the funds’ shareholders when measured against a passive benchmark.

The ad leans heavily on the managers’ outperformance against Lipper Categories, but these are not the same as a passive benchmark. Lipper Categories are simply group comparisons, comprising data gathered from other actively managed funds; given that over any measured period it is common to see 50% to 80% of actively managed funds fail to beat their passive benchmark, using Lipper tells me the Putnam funds beat a bunch of other actively managed funds which on average fail to beat their passive benchmark. Essentially, by using a Lipper average, Putnam has lowered the bar.

Second, the advertisement touts a single year’s performance (2009). Measuring performance over a single year tells investors absolutely nothing other than it would have been nice to have held those funds for that year. Past performance, especially only a single year’s performance, cannot be extrapolated into the future, and leading investors to believe it can is disingenuous.

So what happens when Putnam’s Large Cap funds are properly benchmarked against passive indices over an extended time? The table below shows how the funds in the ad stacked up over the past 10 years to an appropriate market benchmark.
 

 

 

Name

Ticker

Morningstar Category

Total Ret Annlzd 10 Yr

Std Dev 10 Yr

Sharpe  Ratio 10 Yr

Added Value

Putnam Investors

PINVX

Large Blend

-3.75

17.70

-0.28

No

Putnam Research

PNRAX

Large Blend

-1.53

17.51

-0.15

No

Russell 1000 TR USD

 

 

0.16

16.22

-0.07

 

Putnam Voyager

PVOYX

Large Growth

-1.93

18.65

-0.15

Yes

Putnam Growth Opportunities

POGAX

Large Growth

-6.51

19.79

-0.37

No

Russell 1000 Growth TR USD

 

 

-3.63

18.85

-0.24

 

 

Putnam Fund for Growth & Income

PGRWX

Large Value

1.30

15.86

-0.01

No

Putnam Equity Income

PEYAX

Large Value

5.28

14.05

0.25

Yes

Russell 1000 Value TR USD

 

 

3.84

15.72

0.13

 

Morningstar Direct April 30, 2000-April 30, 2010

On both a nominal-return basis and risk-adjusted basis as measured by the Sharpe Ratio (return per unit of risk assumed), only two of the six funds (33%) added any value at all. And the two funds that did add value barely did so once the amount of risk they assumed was factored in. So while it is certainly true that 100% of the Putnam U.S. large-cap funds beat their Lipper Average in 2009, considerably less have beaten their passive benchmark on a nominal or risk adjusted basis over a meaningful period of time.

This is very similar to what the broad-based data confirms and what we see on a daily basis: the majority of actively managed funds can’t beat their passive benchmark. Delivering market-beating returns is a difficult thing to accomplish for mutual funds, so most fund ads seek to change the yardstick by which they are being measured to avoid this unpleasant truth.

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