At the end of each calendar quarter, InvestSense publishes the 5 and 10-year Active Management Value Ratio (AMVR) scores of the non-index funds in “Pensions & Investments” annual survey of the most used mutual funds in U.S. defined contribution plans. Currently there are six such funds.
One of the interesting things about the 2021 survey is the continued growth of investments in index funds. The P&I survey ranks funds based on amount of assets invested in each fund, not the actual performance of the fund. The #1 fund overall is the Fidelity S&P 500 Index Fund. The fund is far and away the leader, holding almost 80% more DC assets than the #2 ranked fund.
The AMVR calculates the cost-efficiency of an actively managed mutual fund relative to a comparable index fund. Section 90 of the Restatement (Third) of Trusts emphasizes the importance of cost-efficicency. In announcing the adoption of the Securities and Exchange Commission’s new Regulation Beast Interest, former SEC Chairman Jay Clayton noted the importance of cost-efficiency, stating that
A rational investor seeks out investment strategies that are efficient in the sense that they provide the investor with the highest possible expected net benefit, in light of the investor’s investment objective that maximizes expected utility.
The AMVR is essentially the basic cost/benefit analysis taught in economic classes, with a fund’s incremental costs and its incremental return as the input values (incremental costs/incremental returns). An AMVR score greater than 1.0 indicates that the actively managed fund is cost-inefficient, as its incremental costs exceed its incremental returns.
Since the six funds funds currently in=the “cheat sheets” are all large cap funds, we use three Vanguard index funds (VIGAX, VFIAX and VVIAX) for benchmarking. While some people use nominal costs and nominal returns, sucb data can often be misleading. For that reason, InvestSense calculates AMVR scores using an actively managed fund’s incremental correlation-adjusted costs (ICAC) and incremental risk-adjusted returns (IRAR).
The impact of a fund’s r-squared, or correlation, number is gaining greater recognition as issues such as “closet indexing” receive increased attention. InvestSense uses Miller’ Active Expense Ratio in computing a fund’s (ICAC). As Miller explained,
Mutual funds appear to provide investment services for relatively low fees because they bundle passive and active fund management together in a way that understates the true cost of active management. In particular, funs engaging in closet or shadow indexing charge their investors for active management while providing them with little more than an indexed investment. Even the average mutual fund, which ostensibly provides only active management, will have over 90% of the variance in its returns explained by its benchmark index.
So, with that background, the new 4Q AMVR cheat sheets are shown below:
Two key numbers to look for in using the AMVR is a fund’s r-squared/correlation number and its expense ratio. As you look at the two charts, you can see how dramatically the combination of a high r-squared number and a high expense impacts a fund’s overall cost-efficiency. This is the main reason InvestSense uses incremental correlation-adjusted costs instead of nominal costs, to get a truer evaluation of a fund’s cost-efficiency.
In analyzing the data, the two key questions are:
1. Did the actively-managed fund provide a positive incremental return?
2. If so, did the fund’s incremental return exceed the fund’s incremental costs?
If the answer to either of these questions is “no,” the actively-managed fund is not cost-efficient, and an imprudent investment choice, relative to the benchmark fund.
As to the 5-year AMVR chart, using the ICAC/AER and IRAR data, none of the six fund’s would be prudent relative to the benchmark.
As to the 10-year AMVR chart, using the ICAC/AER and IRAR data, only the Vanguard PRIMECAP Fund’s Admiral shares would be prudent relative to the benchmark, here the Admiral shares of Vanguard’s S&P 500 Fund.
Two funds deserve particular mention. The significant difference in Dodge& Cos Stock Fund’s return data is due to the fact that they had a relatively high standard deviation (19+). The T. Rowe Price Blue Chip Growth Fund usually produces relatively good returns, but the fund’s unusually high expense ratio negates such performance, especially when the fund’s r-squared number is considered.
Some people have told me that the concept of the AMVR and its calculation process are easier to understand by reviewing some of my PowerPoint presentations and the worksheet examples. Those are available at https://www.slideshare.net. Search under “Active Management Value Ratio” to view all of the available presentations.
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This article is for informational purposes only and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.
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