That was timely. Just after we posted this morning's item on asset bloat in mutual funds, the Journal's Marketbeat reported a few findings from a recent Citigroup assessment of the 50 largest actively-managed U.S. stock mutual funds (which, speaking of bloat, manage $1.8 trillion, fully 37 percent of domestic equity fund assets).
Marketbeat provides only a partial list of these big funds' top holdings, but the names are plenty revealing: General Electric, AT&T, Google, AIG, Microsoft, Coca-Cola, and Pepsi are mentioned as prominent positions. According to Barclays Global Investors, those seven stocks are the 2nd, 4th, 20th, 9th, 5th, 26th, and 25th largest positions, respectively, in the S&P 500 index.
These funds tend to behave like their benchmarks because they pretty much are their benchmarks, and we're sure we'd find more of the same if we saw the full results from Citigroup's analysis.
Given their need to move such enormous amounts of money around, the managers of these giant funds simply must invest in the largest, most liquid securities in the market. And given legal limits on the percentage of a stock's float any single fund can own, the biggest funds truly have no alternative but to invest in securities with the largest market caps.
So it's no wonder that such a huge percentage of the variability in these giant funds' returns can be attributed to their underlying benchmarks.
What does all this mean? As Ross Miller has established, investors in these big funds are effectively paying multiples of their stated expense ratios for the incremental slices of true active management those funds deliver. And that doesn't strike us as a particularly attractive cost-benefit equation.
Ben Warwick, "The True Costs of Active Management: Think mutual funds are cheaper than hedge funds? Not a chance," Investment Advisor, February, 2007