Morningstar: The more you pay, the less you get from funds

High-fee, actively managed funds fail in the long term

Apr 20, 2016 @ 11:19 am

By John Waggoner

Investing in an actively managed fund with high fees is like betting on a smoker to win a marathon, according to a new study released by Morningstar.

Morningstar's active/passive barometer measures actively managed funds against a composite of relevant passive index funds. After all, you can't invest in an actual stock index. The results show how an investor would have fared, net of fees, in actively managed and passive index funds.

Not surprisingly, actively managed funds fared poorly, and those with the highest fees fared the worst. And the longer the time period, the worse most active funds looked. For example, just 27.7% of large-cap blend funds beat their passively managed counterparts in the 12 months ended Dec. 31. That percentage fell to 16.6% over 10 years.

Actively managed funds that played in smaller, less efficient markets fared best against index funds. For example, 66.7% of small-company value funds beat rival index funds in 2015, although that percentage shrank to 23.2% over 10 years. (But 43.3% of the lowest-cost actively managed small-cap funds beat their index counterparts over the past decade).

Overall, actively managed diversified emerging markets funds fared best against the index, beating passive funds 63% of the time last year and 42.9% the past decade. Low-cost diversified emerging markets funds won 61.1% of the time against their index counterparts.

Key takeaways:

• Value managers tended to beat their passive rivals more frequently than other investment styles. Low-cost, mid-cap value funds had a 53.3% chance of success against index funds, while high-cost, mid-cap blend funds had a 5.3% success rate.

• Low-cost funds live longer. Low-cost diversified emerging markets funds led survivorship rate of any other category in the Morningstar study.

• Large-cap growth funds have the highest mortality rate. About half the large-company growth funds survived the past 10 years, and just 12.2% not only survived, but outperformed. High-cost large-cap funds had a 44% survival rate.

• Foreign funds typically had a better chance of beating their benchmarks the past 10 years. (The decision to underweight Japan would probably have helped most funds beat the MSCI EAFE index.)

Morningstar's research is in line with Standard and Poor's, whose SPIVA study, released in March, showed that 82.14% of large-cap managers failed to beat their benchmark index over a 10-year period. The study also found that the majority of international fund managers failed to beat their indexes, either.


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