Yet another study comparing the returns of active and indexed mutual funds has named indexed funds as the clear winners. The study of active mutual funds showed that over a 10-year period ending in 2003, active funds underperformed their benchmark indexes by three to one.
The poor results were not limited to large stocks, moreover: funds in every stock size and investment style category did not do as well as their comparable indexes, said Fulcrum Financial, a Los Angeles-based investment company. For instance, 81% of value stock funds did not match their indexes, while 72% of blended funds and 63% of growth funds failed to keep up with the indexes.
The main culprit was the cost of administering funds: management fees, sales load and redemption fees, brokerage fees and trading spread costs all cut into performance, said David Nolte of Fulcrum. Another problem was the inefficient use of assets: Because investors can sell their shares at any time, active funds have to keep cash available for redemptions. Active funds tended to have larger cash positions—as much as 10% in some cases. Even worse, the study did not account for “survivorship bias.” The long-range statistics used in the study did not include funds that went out of business or were merged into other funds during the study period. Such mergers and closures typically happen when funds perform badly.
The Center for Research in Security Prices at the University of Chicago recently calculated that the average annual gain of U.S. stock funds that existed throughout the 10-year period was 8.8% per year. However, when the returns of funds that closed during that period were included, the average return dropped to 7.2%.
