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Once again, mutual funds underperformed compared to the broader markets but what's more notable, this has largely remained unchanged over the past 10 and 20 year period. In fact, over the past 10 years only 36% of mutual funds managed to beat the S&P 500.

Business Insider speaks to this issue:

Goldman Sachs analysts reviewed the performance of 248 large cap equity mutual funds with a combined $730 billion under management. These are the funds that invest in companies you might find in the S&P 500.

Many of the fund managers in this category try to track the S&P 500 closely, but they have to earn their management fees somehow so they make bets in an attempt to beat the broader market.

The Goldman analysts found that after fees only 43% of the funds have outperformed the S&P 500 so far in 2015.

Though this is above the 10-year average of 36% of funds outperforming, this means that 57% of funds are still underperforming the market this year.

In other words, in the majority of these funds, investors are paying additional fees to money managers so they can allocate the money in a way that makes fewer profits than if they were to simply invest in the S&P on their own.

Goldman SachsGoldman Sachs 

Forbes goes on to summarize:

"According to SPIVA (S&P Indices Versus Active Funds), the statistical “bible” on such arcana, actively managed domestic mutual funds have a rather dismal record when compared against investing in passive indexes. In 2012, 66.08 percent of all domestic equity mutual funds underperformed when matched against the S&P 1500."

"In 2011 a swollen 84.07 percent were laggards, while in 2010 “only” 57.63 did worse than the averages. The S&P 1500 includes the value of 90 percent of all exchange traded stocks."

"SPIVA slices and dices and parses the data into thirteen different categories from the Small Cap Core Funds which are measured against the S&P Small Cap 600 to the Large Cap Funds which do battle with the S&P 500. For the past three calendar years through 2012, every single category, all thirteen of them, on average had returns worse than their respective benchmarks. Of the thirty nine data points (13 x 3 years) only Large Cap Value funds beat (one time) their benchmark."

"In 2010 an impressive 65.33 percent of this class of funds exceeded their hurdle which is the S&P 500 Value Index. But alas, in 2012 they gave it all back and more when a whopping 85.06 percent of these funds once again underperformed their benchmark."

The Fees

According to data from industry trade group ICI (Investment Company Institute) the average fees charged by actively managed equity mutual funds are 1.44%. On the low end there are some under 1%, while others can easily be over 2.5%.

Due to economies of scale a fund with $10 billion in assets can be run more efficiently than a $300 million pool of money, and therefore may carry a lower price tag. Although sales of these types of mutual funds are on the decline, there are still funds with “front end” loads as well as “back end” loads, often referred to as redemption fees.

Redemption fees have some merit as they are often designed to stop traders from moving in and out of the fund attempting to make a quick speculative profit. These fees often decline over time and may go to zero after a few years. There are 12-b1 fees to consider. If you purchase your mutual fund through a retail broker, there is likely a 25 basis point (.25 percent) recurring annual fee tacked on.

There is no reason ever to buy a fund through a broker when you can pick up the phone and call Schwab or Fidelity and do it for free. Assume an all in cost for your fund purchase is 1.5% per year and we pick an investment horizon of 10, 15 and 20 years. Next let’s postulate that before fees this fund has a total return of 9% per annum.

Now let’s compare returns before and after fees… 9% vs. 7.5%. For 10 years at 9% a $1,000 investment becomes $2,370 but when the expenses are deducted your return diminishes to $2,060. As more time passes the effects of compounding further exacerbate the differences.

For 15 years, 9% returns $3,640 while the 7.5% investment yields only $2,950. 20 year totals are $5,600 versus $4,250. Unless you have a super manager these are long odds to overcome.

If an investor purchased the Vanguard S&P 500 ETF (VOO) the expense ratio is only 5 basis points (five hundredths of one percent) or one thirtieth of the actively managed fund. The Blackrock (BLK) iShares S&P 500 Index Fund (IVV) has costs only slightly higher at 7 basis points. With either of these options an investor comes much closer to realizing the actual market returns.

In addition to the fees there is the matter of “cash on hand”. It is further required that a fund manager keeps some portion of the fund assets in cash for normal course of business redemptions and buying opportunities.

On average the cash amount may be as low as 3% and as high as 7%. Other contributing factors as to poor mutual fund returns are diversification and taxes. With all these factors, it becomes clear as to why mutual funds continue to disappoint and underperform.

Morningstar figures show a tale of the underperformance and the effects that fees have had over the past 20 years.

Here are the figures from Morningstar for each of the last 20 years.

Year% of outperforming fundsAverage fund returnS&P return

Note that 2014 was actually the third worst year in terms of the number of funds that managed to outperform; fewer than 1-in-7 managers did so. On average, active funds underperformed by around 1.6 percentage points a year, a big handicap for clients.

There was one year, 1999, when most funds underperformed, but the average return was slightly higher than the market. Still, the average return only beats the market 6 times out of 20. (To be fair, if one takes the average of each of the 20 years, active funds have outperformed 37% of the time. But that's still very low.)

To those who would say that passive funds are also doomed to underperform the market after costs, that is true, but their costs are a lot lower. A shrewd gambler would consider them a much better bet.

GMO has an interesting paper "Is skill dead?" on its website which explains the poor performance of active managers in the large cap sector. It says 3 factors are at work. Managers do not keep 100% of their portfolio in large cap stocks; they tend to have holdings of cash, foreign stocks and small caps.

To the extent that these assets underperform the large cap index, the managers will underperform (and outperform when things go well). Last year, for example, the S&P 500 did much better than cash, international stocks or small caps, so it is hardly surprising that nearly 6 out of 7 managers underperformed.

It's an excuse, but is it a good one? Surely investors buy a US large cap fund to get exposure to large caps, not the other stuff. To the extent that managers go off piste, that can only be justified if they reliably outperform. They clearly don't.

This explanation only makes the lesson clearer; if you want an exposure to US large caps, buy a US largecap index fund with low fees.

Of course, many people will ignore this advice. They see an index fund as a boring product; they want the best in class, a manager that can outperform. And no active manager will admit that they aren't likely to underperform. But it is remarkable how few will put their money where their mouth is.

The current outlook seems to continue this trend for mutual funds. With expected index strengthening there seemingly is no reason to expect better returns from the mutual funds in years to come.

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