New Study Suggests Most Active Investment Managers Not Worth the Fee

BEVERLY HILLS, CA – 23 Mar, 2017 – A new study is providing some intriguing answers to a question that puzzles even the most seasoned investors:  Are active investment managers (e.g., mutual funds and hedge funds) adding value beyond that gained by simply investing in a low-cost index?

Sharath Sury, Executive Director of the Institute for Financial Innovation & Risk Management, a research think-tank, and an adjunct Professor of Economics at the University of California, presented new data at this month’s Family Office Forum in New York, indicating that a majority of long-only equity managers and fixed income managers, as well as many hedge funds and hedge fund of funds, have significant broad market exposure that are already available in much more cost and tax efficient index funds.

In many cases, active management fees are not translating into value above and beyond what a simple combination of index funds may provide, according to Sury. Indexed investment fees are a fraction of the cost of actively managed funds, often ranging from one tenth of one percent (0.1%) to one half of one percent (0.5%). In comparison, hedge funds typically charge a much higher fee (sometimes as much as 2-3% of assets under management plus an additional 20% of any positive performance).  As a result, certain active managers may earn 10 times the cost of an index, while providing similar value. 

“We have known for some time that long-only investment managers tend to closely match their benchmark indexes,” Sury said. “What is surprising is that many hedge funds—and hedge fund of funds—are exhibiting similar patterns with high correlations to simple indexed investments.”  Sury argues that as hedge funds (and fund of funds) become larger and more mature, it is difficult for them to procure risk-adjusted excess returns.  In fact, there is often an incentive for such firms to take a more conservative approach and simply follow the herd and provide average returns.  

However, he added that: “In our study, some managers in certain specific strategies did indeed exhibit high, consistent skill and value. The trick is to weed out those who do not, and have much more focused due diligence on those that do appear to add value.”

In 2006, Sury also introduced a new measure dubbed the “Alpha Cost Index,” that adjusted product fees to account for the level of alpha delivered. Sury’s ACI aimed to level the playing field by penalizing products that charge active management fees but that deliver the preponderance of their returns from broad market exposures.  As a useful ranking tool for due diligence, the measure has been slowly growing in popularity among institutional investment consultants and family investment offices. 

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