Mutual fund managers typically fail over the long term when they try to mimic the investment strategies of rivals at better-performing funds, a study of U.S. mutual funds has found.
"Copycat" mutual funds seek to identify those actively managed funds that post the best returns and the highest inflows of assets. It's a less-expensive approach than investing in research to find, say, under-valued assets that can boost investors' returns.
The research suggests copycatting is a boondoggle. "We find little evidence to suggest that managers are able to detect superior funds," write the researchers.
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The research was conducted by Blake Phillips, Kuntar Pukthuanthong and Raghavendra Rau, professors of finance at the University of Waterloo in Ontario, Canada; the University of Missouri; and the Judge Business School at Cambridge University in the U.K., respectively.
The researchers looked at the performance of more than 4,000 U.S. mutual funds between 1991 and 2013 and found several hundred copycats – typically distressed vehicles that adopted mimicking behavior in an effort to reverse underperformance or stem investor redemptions.
The study acknowledges that, despite more than a half-century of academic research, the jury is still out on the value of actively managed funds compared to cheaper, passively managed index funds.
The researchers, however, cite recent research showing that certain active fund managers clearly outperform index funds.
The question the researchers pose is whether the most successful fund managers can be recognized "ex ante." In other words, can the ability of those managers to beat markets be predicted by copycat funds?
The bottom line, they said, is that copycat funds show some success in identifying and mimicking superior fund managers, but less success in implementing their longer-term strategies.
Copycat funds showed some improvement in returns in the first year after the mimicking begins, the research found. But considering performance over a longer horizon of four years, copycat funds' returns diminish significantly compared to the funds they mimic.
"Copycat funds … are unable to identify funds with persistent superior performance," conclude the researchers.
The study isn't expected to end the long-running debate over the value of actively managed funds relative to cheaper index funds.
Presenting last week at the Center for Due Diligence Conference, John Doyle, a senior defined contribution specialist at Los Angeles-based American Funds, said the average active manager doesn't beat the index.
But not all active managers are average, said Doyle. An analysis of American Funds' active equity funds showed they outperformed relative index funds 91 percent of the time over the 10-year period ending in 2013.
Doyle's presentation at CDDC came on the heels of a report from the Government Accountability Office suggesting that the purported benefits of actively managed funds are often offset by their costs.
About 78 percent of stock mutual funds assets are in actively managed funds, according to Morningstar.
The good news in the study was that relatively few actively managed mutual funds employ copycat strategies and those that do, do so out of desperation.
Mimicking strategy, the researcher said, would likely be implemented more broadly, if only it were effective.
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Nick Thornton
Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.
