Mutual Funds Underperform and Disappear at a High Rate

Fees are a big hurdle for fund managers to overcome in terms of performance. Adding to the challenge of selecting good actively managed mutual funds is the high rate at which mutual funds cease to exist.

Fees are a big hurdle for fund managers to overcome in terms of performance. “Across various categories within the domestic equity space, the overwhelming majority of active managers, both retail and institutional, lagged their respective benchmarks on a net-of-fees basis,” observe the authors of the S&P Indices Versus Active (SPIVA) U.S. Scorecard.

During the 10-year period ending June 30, 2018, more than 89% of domestic large-cap stock, 92% of mid-cap and 93% of small-cap funds underperformed their benchmarks. Foreign funds fared better, though most still underperformed: 77% of international, 63% of international small-cap and 86% of emerging market funds had 10-year annualized returns below that of their comparable S&P benchmark indexes.

Rates of long-term underperformance are high for fixed-income funds too. Most government long-term (95%), investment-grade (96%) and high-yield (97%) bond funds have underperformed their respective Barclays benchmark bond indexes. The data makes the relative returns of short- and intermediate-term investment-grade funds seem good in comparison, with 52% and 50% of these funds underperforming on a 10-year annualized basis.

In all cases, the percentage of underperforming funds increases once fees are factored in. This matters because investors realize returns on a net-of-fee basis and individual investors have no ability to negotiate these fees.

Adding to the challenge of selecting good actively managed mutual funds is the high rate at which mutual funds cease to exist. During the 15-year period ended in June 2018, “58.58% of domestic equity funds, 53.66% of international equity funds, and an average of 52.16% of all fixed-income funds were merged or liquidated.” For an investor seeking a long-term investment, the odds of the average mutual fund staying in existence over the next 15 years isn’t much better than a coin flip.

Some actively managed funds do stay in existence and outperform over the long term. The challenge is being able to identify such funds in advance without knowing what their actual future relative performance will be.

The SPIVA scorecard is published by S&P Dow Jones Indices and tracks the performance of mutual funds. The performance figures reported include both existing funds and those that have either been closed or merged over the measured time periods.

Sources: “SPIVA Institutional Scorecard: How Much Do Fees Affect the Active Versus Passive Debate?,” March 15, 2018, and “SPIVA U.S. Scorecard,” October 17, 2018; by Aye M. Soe, Berlinda Liu and Hong Xie; S&P Dow Jones Indices.