Fama/French: "Luck versus Skill in Mutual Fund Performance" (LMVTX)

There are little treasures scattered everywhere on the internet, here's one of them.
From the Fama/French Forum at Dimensional Fund Advisors:

By Eugene F. Fama and Kenneth R. French
Our paper, "Luck versus Skill in the Cross Section of Mutual Fund Returns," examines the performance during 1984-2006 of actively managed US mutual funds that invest primarily in US equities.  It is an academic paper with lots of technical detail.  The purpose of this white paper is to provide a summary of the results that are relevant for investors.  We begin by examining the overall α for aggregate wealth invested in actively managed mutual funds.  We then turn to the performance of individual funds.

Aggregate Returns for US Equity Mutual Funds
Suppose we form a portfolio of actively managed US equity mutual funds, where each fund is weighted every month by assets under management. This is the aggregate portfolio of wealth invested in active mutual funds, and its performance is the aggregate experience of fund investors. For 1984-2006, the α (abnormal return) of the portfolio, measured with our three-factor model, is ‑0.81% per year. This α estimate is 2.50 standard errors below zero, which is rather strong evidence that active mutual funds as a whole provide returns to investors below those of an equivalent portfolio of the three passive benchmarks of the FF model.

The high management fees and expenses of active funds lower their returns. If we measure fund returns before fees and expenses - in other words, if we add back each fund's expense ratio - the α estimate for the aggregate fund portfolio rises to 0.13% per year, which is only 0.40 standard errors from zero. Thus, even before expenses, the overall portfolio of active mutual funds shows no evidence that active managers can enhance returns. After costs, fund investors in aggregate simply lose the fees and expenses imposed on them.

Adding insult to injury, the aggregate portfolio of active mutual funds looks a lot like the cap-weighted stock market portfolio. When we use the three-factor model to explain the monthly percent returns of the aggregate fund portfolio for 1984-2006, we get,
R_Pt - R_ft = -0.07 + 0.96(R_Mt - R_ft) + 0.07SMB_t - 0.03HML_t + e_it, where R_Pt is the return (net of costs) on the aggregate mutual fund portfolio for month t, R_ft is the riskfree rate of interest (the one-month T-bill return for month t), R_Mt is the cap-weighted NYSE-Amex-Nasdaq market return, and SMB_t and HML_t are the size and value/growth returns of the three-factor model.
The regression says that the aggregate mutual fund portfolio has almost full exposure to the market portfolio (a 0.96 dose, which is close to 1.0), but almost no exposure to the size and value/growth returns (0.07 and -0.03, which are close to zero). Moreover, the market alone captures 99% of the variance of month-by-month aggregate fund returns.

In short, the combined portfolio of all active mutual funds is close to the cap-weighted market portfolio, but with a return weighed down by the high fees and expenses of actively managed funds.

Are Winners Skilled or Lucky?
The fact that the aggregate portfolio of wealth invested in active mutual funds shows no evidence of manager skill does not mean no fund managers have skill. It simply means that if there are good managers who produce positive α, they must be balanced by bad managers who produce negative α. Can we find evidence of good and bad managers?...MUCH MORE

The good professors also conduct a sort of Dear Abby for wonks:

Q&A: Why Use Book Value to Sort Stocks?
Q&A: Cap Weighting or GDP Weighting?
Q&A: Expected Returns and Socially Responsible Investing
Q&A: Front Running and Fair Pricing

I dug this out of the link-vault because my memory was jogged yesterday by a post at MarketBeat quoting Legg Mason's Bill Miller. I commented that Miller was a "One-trick mo-mo pony" and that despite his record-setting 16 year run of beating the S&P he wasn't that good a manager.

In the 90's, during the middle of his streak he went with the momentum tech names. During the 2000's he switched to the momentum financials. Here's the complete record of his Legg Mason Capital Value Trust vs. the S&P 500:

You'll note that during the period of his streak, 1991-2005, Mr. Miller was closing the gap caused by the fund's 1980's under-performance but never did make up the difference.

The portfolio's holdings of Countrywide Mortgage, AIG, Wachovia, Freddie Mac, Bear Stearns etc. affected performance negatively after mid 2007.

Since January 1, 2000 LMVTX has lost more than 50% vs. the S&P's 21% loss, a poor performance on either a relative or an absolute basis.