Markets, Portfolio Management
Over the last several months volatility has reasserted itself as a feature of the global stock markets. As is often the case when the tide rolls out (AKA volatility reemerges) those who have been swimming naked get revealed. In the mutual fund world, this is akin to seeing which funds have working risk management protocols and which funds have malfunctioning risk management protocols, or none at all. Overall, we have found that for the vast majority of the largest global funds, the risk management protocols seem to be either malfunctioning or non-existent. The vast majority of these funds are exposing investors to even more downside risk than the broad market and the funds that have declined less than their benchmarks have only declined a fraction less.Method:In the study carried out below we reviewed the performance of every World Stock and Diversified Emerging Market mutual fund with assets under management (AUM) greater than $1B. We limited the study to I and Y share classes so as to capture the share classes with the lowest fees and we only studied one share class per fund (the lowest fee class) if the fund has both I and Y shares. For each fund category there were 33 funds with an AUM greater than $1B. For World Stock funds we measured total return performance relative to the MSCI World Index since its peak on 5/21/2015 and for Diversified Emerging Markets Funds we measured total return performance relative to the MSCI EM Index since its peak on 4/28/2015. As of the close on 8/24/2015, the MSCI World Index was down 11.9% and the MSCI EM Index was down 26.6%.
Results for the Largest World Stock Mutual Funds:

Since the MSCI World Index made its cyclical peak on 5/21/2015, 36% of World Stock funds have gone down less than the index and 64% of funds have gone down more than the index. The average World Stock fund has realized 95.7% of the decline and thus was able to sidestep only 4.3% of the decline. The median fund has realized 97.2% of the decline and thus was only able to sidestep 2.8% of the decline. That is to say that the average fund avoided 51 basis points and the median fund avoided 33 basis points of the 11.9%, or 1189 basis point, decline of the MSCI World Index. Only four of these largest 33 funds have been able to avoid 20% of the decline and only one fund has been able to avoid 40% of the drawdown so far. We must conclude then that in general the largest World Stock mutual funds have provided no or de minimis capital preservation characteristics during this drawdown. Almost all of them have been swimming naked. Tables 1 and 2 below summarize these findings.

Largest Global Mutual Funds
Largest Global Mutual Funds
Largest Global Mutual Funds
Largest Global Mutual Funds

[drizzle]Results for the Largest Diversified Emerging Market Mutual Funds:

Since the MSCI Emerging Market Index made its cyclical peak on 4/28/2015, 21% of Diversified Emerging Market funds have gone down less than the index and 79% of funds have gone down more than the index. The average Diversified Emerging Market fund has realized 92.3% of the decline and thus was able to sidestep only 7.7% of the decline. The median fund has realized 93.2% of the decline and thus was only able to sidestep 6.8% of the decline. That is to say that the average fund avoided 205 basis points and the median fund avoided 181 basis points of the 26.6%, or 2659 basis point, decline of the MSCI Emerging Market Index. Only three of these largest 33 funds have been able to avoid 20% of the decline and not one has been able to avoid 40% of the drawdown so far. Much the same as our conclusions for the World Stock funds, we must conclude that in general the largest Diversified Emerging Market mutual funds have provided no or de minimis capital preservation characteristics during this drawdown. Almost all of them have been swimming naked. Tables 3 and 4 below summarize these findings.

Largest Global Mutual Funds
Largest Global Mutual Funds
Largest Global Mutual Funds
Largest Global Mutual Funds

Largest Global Mutual Funds Discussion:

As a group the largest global stock funds seem to be providing investors with no or very little risk management or capital preservation features. In fact, the vast majority of global mutual funds seem to be exposing investors to even more downside risk than the broad stock indexes they are designed to outperform. Of the funds that have been able to outperform the broad indexes, most have done so by no more than a rounding error. While an obvious statement, investors that want different results than those provided by the largest global mutual funds must look to products that perform differently than the market. This can be accomplished in two ways. One can look to rules based investment strategies like smart beta ETFs that have unique selection and weighting processes, or one can look to highly active and unconstrained mutual funds that have both high tracking error and different holdings relative to their benchmark. Most likely, investors will have to venture outside of the largest ETFs and mutual funds to find products that meet those characteristics.

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