Boston based money manager, Putnam Investments, has fallen on some hard times. As reported in this Boston Globe article, the company announced that it is going to cut 115 jobs or about 8% of its workforce given the continued outflow of assets from their firm. Currently managing over $150 billion in assets across almost 80 different strategies, the firm blames the rise of passive investing for its current predicament.
According to wikipedia, "Putnam Investments is a privately owned investment management firm founded in 1937 by George Putnam, who established one of the first balanced mutual funds, The George Putnam Fund of Boston. As one of the oldest mutual fund complexes in the United States, Putnam has over $125 billion in assets under management, 79 individual mutual fund offerings, 96 institutional clients, and over seven million shareholders and retirement plan participants." In the History section of wikipedia, it states that "In early 2004, the company admitted to allowing its portfolio managers and some investors to market time its funds. Under agreements with the SEC and the Secretary of the Commonwealth of Massachusetts, Putnam paid $110 million in fines and restitution to settle charges with the state and federal regulators. After allegations of improper trading became public, Putnam's investors withdrew at least $28 billion from its stock and bond funds over a six-month period. By May, 70 civil actions had been filed against Putnam for allegedly engaging in improper trading. In 2005, Putnam paid $40 million to settle charges made in 2003 that it "did not tell fund investors or directors about paying" brokerage firms for recommending its mutual funds to clients. Afterward, some investors withdrew their funds. This settlement was the final resolution in an investigation of Putnam’s payments to 80 brokers that was conducted over a three-year period."
Although nearly $216 billion has already left the active management community so far this year, leadership at Putnam remains steadfast in their investment acumen. According to Chief Executive, Robert Reynolds, “Putnam continues to see strong, ongoing opportunity for active management in the marketplace.”
This statement may be true, but as we are about to show, many investors will not be looking to Putnam as the “active experts” in the near future. We will take a deep dive into the historical performance of Putnam in order to better understand its luster.
We have taken a deeper look at the performance of several other mutual fund companies, which you can review by clicking any of the links below:
Our analysis begins with an examination of the costs associated with the 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), level (B) and deferred (C) loads, and 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 costs associated with implementing a particular investment strategy and can vary depending on the frequency and size of the trades taken by portfolio managers. We can estimate the amount of cost 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 1 year. This is considered an active approach and investors holding these funds in taxable accounts will likely incur a higher exposure to tax liabilities to short term and long term capital gains distributions relative to incurred by passively managed funds.
The table below details the hard costs as well as the turnover ratio for all 73 active funds offered by Putnam that have at least 3 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 equity strategy from Putnam experienced a 1.19% expense ratio, a 0.25% 12b-1 fee, and a 5.75% max front-end load for equity funds with a load. Similarly, an investor who utilized a bond strategy from Putnam experienced a 0.92% expense ratio, a 0.30% 12b-1 fee, and a 4.00% max front-end load for bond funds with a load. This can have a substantial impact on an investor’s overall accumulated wealth if it is not backed by superior performance. The average turnover ratios for equity and bond strategies from Putnam were 106.36% and 221.96%, respectively. This implies an average holding period of about 5 to 12 months, on average. It is safe to say that Putnam makes investment decisions based on short-term outlooks, which means they trade quite 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.
The next question we address is whether investors can expect superior performance in exchange for the higher costs associated with Putnam’s “expertise.” We compare each of the 73 strategies that have at least 3 years of performance history since inception and against its current Morningstar assigned benchmark to see just how well each has delivered on their perceived value proposition. We have included alpha charts for each strategy at the bottom of this article. Here is what we found:
- 67% (49 funds) have underperformed their respective benchmarks since inception, having delivered a NEGATIVE alpha
- 33% (24 funds) have outperformed their respective benchmarks since inception, having delivered a POSTIVE alpha
- 0% (0 funds) have outperformed their respective benchmarks consistently enough since inception to provide 95% confidence that such outperformance will persist as opposed to being based on random outcomes
It is important to mention that these performance figures do NOT include the front-end load. If an investor paid the front-end load, their return is worse than the results we show here. Not all investors pay the front-end load depending on who sold the fund to the investor, if the fund is in a qualified retirement plan, etc.
In general, we conclude that Putnam has no reasonable expectation of producing above-average returns for their investors. The vast majority (67%) of their funds didn’t beat the Moringstar assigned benchmark since their inception. The inclusion of statistical significance is key to this exercise as it indicates which outcome is the most likely vs. random-chance outcomes.
Now some readers may believe that we are not properly analyzing performance since we do not take into account risk (Beta). We understand your concern. Because 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 for these possible discrepancies is to run multiple regressions where we account for the known dimensions (Betas) of expected return in the US (market, size, relative price, etc.). For example, if we were to look at all of the US based strategies from Putnam who have been around for at least the last 10 years, we could run multiple regressions to see what their alpha looks like once we control for Beta. The chart below displays the average alpha and standard deviation of that alpha for the last 10 years ending 12/31/2015.
As you can see, not a single fund produced an alpha that was statistically significant at the 95% confidence level (green shaded area). This is what we would expect in a well functioning capital market.
Like many of the other largest financial institutions, a deep analysis into the performance of Putnam has yielded a not so surprising result: active management is failing many of its 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.
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.
About the Authors
Tom Allen is an Accredited Investment Fiduciary (AIF®), Certified Cash Balance Consultant (CBC) and a Chartered Financial Analyst (CFA®) Level III Candidate. Tom received his Bachelor of Science in Management Science as well as his Bachelor of Art in Philosophy from the University of California, San Diego.
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.