High-fee mutual funds may still not be worth it

A new year merits a fresh examination of everything, including previously established conclusions about high-fee mutual funds and their general underperformance after expenses. Unfortunately, one fresh analysis suggests that things haven’t changed.

According to an analysis by Dr. Derek Horstmeyer, an assistant professor of finance at George Mason University’s Business School, actively managed mutual funds in the US with relatively high expense ratios (over 1.5%) are associated with “some of the worst performing and most poorly managed funds, especially in the US-stock category.

“Consider the performance difference between high-fee and low-fee active funds focused on large-cap US stocks,” Horstmeyer wrote in the Wall Street Journal. In the 10 years through Q3 2018, he said, the average high-fee option delivered an average annual return of 10.61% after expenses, compared to 12.26% for the average low-fee option. Looking at median annual returns for the period didn’t narrow the gap much: the annual return for the median high-fee option was 10.8% compared to 12.36% for the median low-fee option.

“The underperformance gets worse when we focus on even higher-cost mutual funds,” he said. Focusing on large-cap US stock funds with fees of over 2%, he said their average 10-year return fell another 0.6% to 10.01%.

Horstmeyer also found performance gaps in other asset classes. Over a 10-year horizon, he said, low-cost actively managed mutual funds outdid their high-fee peers by 1.1% on an annual basis; for actively managed REITs, the difference was 1.14%.

He added that high-fee large-cap US stock funds were also “associated with elevated levels of risk and excessive portfolio turnover.” Looking at the swings in price of such funds, which were calculated using monthly fund returns, he reported that high-fee options had an average volatility of 11.54% over the past two years, while low-fee options exhibited less severe oscillations at 10.23%. As for asset turnover, he said high-fee funds sell or buy 67% of their assets under management in a given year, whereas their lower-fee peers manage to do so with just 35% of their assets.

“This is perhaps a sign that these managers attempt to trade more to justify the fee they charge, but from the investor’s point of view, this only leads to a higher tax bill due to short-term capital gains and an even lower posttax return,” Horstmeyer said.

Citing stewardship ratings from Morningstar, he said high-fee funds also have a 30% greater chance of receiving a failing rating for poor governance, which could stem from regulatory issues, poor managerial incentives and practices such as charging hidden fees.

“An exception to the vast underperformance of high-fee mutual funds may be fixed-income mutual funds,” he noted. Though high-fee fixed-income funds still underperform their low-fee counterparts by 0.18% within the 10-year horizon, Horstmeyer found a good number of high-fee options that bested their low-fee rivals consistently over time.

Follow WP on Facebook, LinkedIn and Twitter