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Robert Olstein is the manager of the Olstein All Cap Value Fund (OFALX). As of December 6, 2013 OFLAX had about $650 million of assets under management - an amazing figure given the fund's expense ratio of 2.3 percent. You would think that given that high an expense ratio the fund must have generated great returns in order to justify the investment. And given the fee, it shouldn't come as a surprise that when Olstein was asked about index funds he angrily responded: "What do you mean I can't beat the market?"

In a December 7, 2013 interview with the New York Times Olstein stated that index funds give you mediocrity. And while he acknowledged that most active managers underperform, he aims for much better. He stated: "The rise of index funds is part of a trend toward sloppy investing - a willingness to follow the herd." He added: "It (index investing) is like saying mediocrity is O.K. - that it's more than O.K., it's the best that anyone should hope for. It's saying a guy like me can't beat the market - that he shouldn't even bother trying. That's wrong! It really ticks me off. I can beat the market. I have beaten the market." And, in fact he has. According to Morningstar, for the 15-year period ending December 6, 2013 his fund returned 8.45 percent per year. That compares to a return of just 4.82 percent for the S&P 500 Index (SPY) and 4.72 percent for Vanguard's 500 Index Fund (VFINX). However, given that the Olstein's fund is an all-cap value fund, using the S&P 500 as a benchmark isn't appropriate.

Comparing Returns to Value Benchmarks

There's an overwhelming body of evidence demonstrating that value stocks have outperformed the market. Thus, we shouldn't be comparing OFALX to VFINX. Instead, we should be comparing its performance to that of the performance of passively-managed alternatives. We can do that by comparing OFALX's performance to the passively-managed value funds of Dimensional Fund Advisors as well as value index funds of Vanguard. [Full disclosure: My firm Buckingham recommends Dimensional funds in constructing client portfolios.] Before doing so, it's worth pointing out that as an active manager running an "all-cap" value strategy, OFALX has the "advantage" of shopping around, buying whatever is the most underpriced. That means he can not only buy large-value and small-value stocks, he can also shift his assets around constantly to take advantage of current mispricings. Further, Olstein isn't limited to the academic definition of value stocks (the stocks of companies with low prices-to-book values). This is in contrast to the DFA and Vanguard funds that are limited to only owning either small-value or large-value stocks as is appropriate for the particular fund. They don't have the freedom to shop around the entire universe like Olstein does.

Olstein Versus Vanguard's Value Index Funds

We'll begin by comparing the performance of OFALX with the performance of Vanguard's large-value (VIVAX) and small-value index funds (VISVX). And while we don't know what OFALX's asset allocation was over any particular period, since the current allocation of OFALX is roughly 50 percent large caps (the remainder being mid and small caps), the table below also compares the returns of OFALX with the simple weighted average returns of a portfolio that is 50 percent VIVAX and 50 percent VISVX. All data is from Morningstar and is for the period ending December 6, 2013.

Fund

Annualized Returns 5 Years (%)

Annualized Returns 10 Years (%)

Annualized Returns 15 Years (%)

OFALX

19.6

5.5

8.5

VFINX

18.0

7.5

4.7

VIVAX

16.4

7.8

5.6

VISVX

21.5

9.7

10.1

50% VIVAX/50% VISVX

19.0

8.8

7.9

OFALX did manage to outperform the market (VFINX) over the 15-year period. However, all that outperformance was in the first five years. For the last 10 years OFALX has underperformed VFINX by 2 percent a year. Even if OFALX goes on to outperform in the future, one can only wonder how many investors will be there, having had to endure at least 10 years of underperformance.

Further, the analysis reveals that OFALX underperformed the simple, no brainer, mindless small-value fund (VISVX) in all three of the time periods, with the underperformance ranging from 1.6 percent to as much as 4.2 percent. Remember OFALX has the freedom to buy whatever stocks it wants. So much for the supposed advantage of being able to be an all-cap value fund, with the whole value universe to shop from, and not even being limited to the academic definition of value stocks.

Looking at the 50/50 portfolio there doesn't seem to be much to differentiate Olstein's performance from that of the indexing strategy. And again, the 0.6 percent outperformance of OFALX that we see over the 15 years doesn't look so good in light of its underperformance by 3.3 percent over the last 10 years. Perhaps Olstein once had the "magic touch," but either he lost it, or the market has become a lot more efficient.

We'll now perform the same comparative analysis using the funds of DFA.

Olstein Versus DFA

While eschewing stock picking and market timing, DFA also eschews a pure-indexing approach because there are negatives of indexing that are the "price" of avoiding tracking error. Note that the advantages gained by DFA's structured (but passive) approach are why my firm has been using DFA's funds for almost 20 years now.

Fund

Annualized Returns 5 Years (%)

Annualized Returns 10 Years (%)

Annualized Returns 15 Years (%)

OFALX

19.6

5.5

8.5

DFLVX

21.6

9.2

8.0

DFSVX

23.9

10.2

12.2

50% DFLVX/50% DFSVX

22.8

9.7

10.1

Now the results are quite different. The only outperformance for OFLAX was versus DFLVX for the 15-year period, and the outperformance was just 0.5 percent a year. It underperformed DFLVX over the recent 10-year period by 3.7 percent a year, by 2 percent a year over the last five years. OFLAX also underperformed DFSVX over each of the three periods, with the underperformance ranging from 3.7 percent a year to 4.7 percent a year. And finally, OFLAX underperformed the 50/50 DFA portfolio in all three periods, with the underperformance ranging from 1.7 percent a year to 4.2 percent a year.

Summary

Perhaps there was a period when Olstein was able to add value with his stock selection efforts - though the last 10 years certainly now calls that into question. And perhaps one might even make the case, at least to some degree, that Olstein has ability to pick undervalued stocks. The problem is that his 2.3 percent expense ratio means he's personally capturing the value of the skill, not his investors. And by the way, given that the ability to generate alpha (outperformance) is such a scarce resource, that's exactly the outcome economic theory predicts - economic rents go to the scarce resource.

Source: What Do You Mean I Can't Beat The Market?