USAA-Victory Capital Mutual Funds: A Deeper Look at the Performance

The United Services Automobile Association (USAA) traces its roots to the roaring '20s, a time when military members found it difficult to insure their prized possessions. Just a few years removed from World War I, working as a soldier was considered too risky of a profession by insurers. So, a group of Army officers gathered in San Antonio, Texas, in 1922 to help start a company that would offer polices to cover their cars. 

Now, USAA is one of the largest insurance carriers in the country. While originally an auto insurer, today it offers a gamut of policies -- from home and life to business and flood insurance. USAA has also branched into banking and associated lending services. In all, the financial services provider counts tens of millions of current and former military members and their families as customers. By 2017, the company reported in a letter to members that its net revenue had reached $30 billion and assets topped $155 billion.¹ 

In late 2018, however, USAA struck an agreement to sell its $69.2 billion asset management business to Victory Capital. At the time, a company spokesman credited such a move to challenging conditions related to price competition and rising technology costs of managing funds, according to industry trade publication InvestmentNews.²   

Since it has grown by purchasing other fund companies, Victory Capital is characterized as a "rollup" investment manager. Previous acquisitions include former rivals such as RS Investments, Harvest Volatility Management and Munder Capital. The publicly traded company (VCTR) now lists its headquarters as San Antonio, Texas, and was founded in 2013.

As reported by RIAbiz, USAA represented Victory Capital's 12th and largest deal to date -- one which had to be at least partially funded by Victory Capital through more than $1 billion in loans. In explaining why they made such a major acquisition, the trade publication noted that Victory executives highlighted the brand's large military following and high retention rates by USAA fund investors.³  

While we recognize USAA's pioneering efforts as an insurance provider and banker for those who've served in the military, an objective investor might ask: Has USAA's family of actively managed mutual funds lived up to its insurance and banking pedigree? 

For years, we've been digging into the historical performances of fund families through our Deeper Look research series. In this installment, we've put under our microscope the active mutual fund strategies run by both USAA and Victory Capital.

Controlling for Survivorship Bias

It's important for investors to understand the idea of survivorship bias. While there are 74 active mutual funds that are currently offered by the combined USAA-Victory Capital investment management firm, it doesn't necessarily mean that these are the only strategies that these companies have ever managed. In fact, there are 44 mutual funds that no longer exist. This can be for a variety of reasons including poor performance or the fact that they were merged with another fund. We will show what their aggregate performance looks like shortly.

Fees & Expenses

Let's first examine the costs associated with USAA-Victory Capital's surviving 74 strategies. It should go without saying that if investors are paying a premium for investment "expertise," then they should be receiving above average results consistently over time. The alternative would be to simply accept a market's return, less a significantly lower fee, via an index fund.

The costs we examine include expense ratios, front end (A), deferred (B) and level (C) loads, as well as 12b-1 fees. These are considered the "hard" costs that investors incur. Prospectuses, however, do not reflect the trading costs associated with mutual funds.

Commissions and market impact costs are real expenses associated with implementing a particular investment strategy and can vary depending on the frequency and size of the trades executed by portfolio managers.

We can estimate the costs associated with an investment strategy by looking at its annual turnover ratio. For example, a turnover ratio of 100% means that the portfolio manager turns over the entire portfolio in one year. This is considered an active approach and investors holding these funds in taxable accounts will likely incur a higher exposure to tax liabilities, such as short- and long-term capital gains distributions, than those incurred by passively managed funds.

The table below details the hard costs as well as the turnover ratio for all 74 surviving active funds offered by USAA-Victory Capital that have at least three years of complete performance history. You can search this page for a symbol or name by using Control F in Windows or Command F on a Mac. Then click the link to see the Alpha Chart. Also, remember that this is what is considered an in-sample test; the next level of analysis is to do an out-of-sample test (for more information see here).

On average, an investor who utilized an active equity strategy from USAA-Victory Capital experienced a 1.14% expense ratio. Similarly, an investor who utilized an active bond strategy from the company experienced a 0.66% expense ratio.

These expenses can have a substantial impact on an investor's overall accumulated wealth if they are not backed by superior performance. The average turnover ratios for active equity and bond strategies from USAA-Victory Capital were 71.91% and 45.57%, respectively. This implies an average holding period of 16.69 to 26.33 months.

It's safe to say that USAA-Victory Capital makes investment decisions based on relatively short-term outlooks, which means they trade fairly often. Again, this is a cost that is not itemized to the investor but is definitely embedded in the overall performance.

In contrast, most index funds have very long holding periods--decades, in fact, thus deafening themselves to the random noise that accompanies short-term market movements, and focusing instead on the long-term.

Performance Analysis

The next question we address is whether investors can expect superior performance in exchange for the higher costs associated with USAA-Victory Capital's implementation of active management. We compare each of its 118 strategies, which includes both current funds and funds no longer in existence, against its Morningstar assigned benchmark to see just how well each has delivered on their perceived value proposition.

We have included alpha charts for each of their current strategies at the bottom of this article. Here is what we found:

• 73.73% (87 of 118 funds) have underperformed their respective benchmarks or did not survive the period since inception.

• 26.27% (31 of 118 funds) have outperformed their respective benchmarks since inception, having delivered a POSITIVE alpha.

Here's the real kicker, however:

• 1.69% (2 of 118 funds) have outperformed their respective benchmarks consistently enough since inception to provide 97.5% confidence that such outperformance will persist as opposed to being based on random outcomes.

It's safe to say that the majority of funds offered by USAA-Victory Capital have not outperformed their Morningstar assigned benchmark. The inclusion of the statistical significance of alpha is key to this exercise, as it indicates which outcomes are due to a skill that is likely to repeat and those that are more likely due to a random-chance outcome.

Regression Analysis

How we define or choose a benchmark is extremely important. If we relied solely on commercial indexes assigned by Morningstar, then we may form a false conclusion that USAA-Victory Capital has the "secret sauce" as active managers.

Since Morningstar is limited in terms of trying to fit the best commercial benchmark with each fund in existence, there is of course going to be some error in terms of matching up proper characteristics such as average market capitalization or average price-to-earnings ratio.

A better way of controlling these possible discrepancies is to run multiple regressions where we account for the known dimensions (betas) of expected return in the U.S. (i.e., market, size, relative price, etc.).

For example, if we were to look at all of the U.S.-based strategies from USAA-Victory Capital that've been around for the past 10 years, we could run multiple regressions to see what each fund's alpha looks like once we control for the multiple betas that are being systematically priced into the overall market.

The chart below displays the average alpha and standard deviation of that alpha for the past 10 years ended 12/31/2019.

As you can see, although four mutual funds had a positive excess return over its benchmark, only one barely had a statistically significant alpha (greater than 2.0). 

Why is this important? It means that if we wanted to simply replicate the factor risk exposures to these USAA-Victory Capital funds with indexes of the factors, we could blend the indexes and capture similar returns. 

To get similar risks and returns in a mutual fund would require the additional fees of those passively managed funds. That would alter such an analysis, but not by much because of the relatively low fees of the passively managed funds compared to the actively managed funds.

Given the lower costs associated with index funds, we could have more confidence that we will experience a more desirable result compared to more expensive actively managed funds.

Conclusion

Like many of the other largest financial institutions, a deep analysis into the performance of USAA-Victory Capital has yielded a not so surprising result: active management is likely to fail many investors. We believe this is due to market efficiency, costs, and increased competition in the financial services sector.

As we always like to remind investors, a more reliable investment strategy for capturing the returns of global markets is to buy, hold and rebalance a globally diversified portfolio of index funds.

Below are the individual alpha charts for the existing USAA-Victory Capital mutual funds that have five years or more of a track record.

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Here is a calculator to determine the t-stat. Don't trust an alpha or average return without one.

The Figure below shows the formula to calculate the number of years needed for a t-stat of 2. We first determine the excess return over a benchmark (the alpha) then determine the regularity of the excess returns by calculating the standard deviation of those returns. Based on these two numbers, we can then calculate how many years we need (sample size) to support the manager's claim of skill.

Footnotes:

1.) USAA, 2017 Report to Members, May 2018. 

2.) InvestmentNews, "USAA Retreats from Asset Management Business with $850 million Sale to Victory Capital," Nov. 8, 2018. 

3.) RIAbiz, "Victory Capital to Pay $1 Billion," Nov. 17, 2018. 

UsaaMutual FundVictory CapitalT-StatAlphaPerformanceAlpha MythManagersStyle AnalysisRegressionStocksBonds

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Index Fund Advisors, Inc. (IFA) is a fee-only advisory and wealth management firm that provides risk-appropriate, returns-optimized, globally-diversified and tax-managed investment strategies with a fiduciary standard of care.

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About the Authors

Mark Hebner - Founder, Index Fund Advisors, Inc.  

Founder and President of Index Fund Advisors, Inc., and author of Index Funds: The 12-Step Recovery Program for Active Investors. He is a Wealth Advisor, with an MBA from the University of California at Irvine and a BS in Pharmacy from the University of New Mexico with a specialization in Nuclear Pharmacy.

Murray Coleman - Investment Writer - Index Fund Advisors

Murray is an investment writer at Index Fund Advisors. Prior to joining IFA, he worked as a funds reporter for The Wall Street Journal, The Financial Times, Barron's and MarketWatch.

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