Can low fund fees tell us about the performance of a fund? Morningstar recently conducted a study looking at the effect of mutual fund fees on the returns and success of those funds and found that the expense ratio is the most proven predictor of future fund success. Though the conclusion might be to use all index funds, the real insight is to pick funds that are reasonably priced whether active or passive which means paying close attention to share classes.
The Morningstar analysis look at funds over four years ending 12/31/15 and created a success ratio looking at:
- total return over the ensuing period,
- load-adjusted returns,
- standard deviation,
- investor returns, and
- subsequent Morningstar Rating.
Funds that did not survive were not included in the analysis. Remaining funds were put into quintiles. The results were telling. Looking at US equities, for example, the success ratio of the top 20% cheapest funds was 62% compared with 20% for the most expensive ones. Other asset categories showed similar results.
Famed investor Warren Buffet bet that a Vanguard S&P 500 index fund would outperform a basket of hedge funds selected by a consultant from 2008 through 2017. So far the results are stunning. Hedge funds selected by the consultant returned 21.9% while the index fund rose 65.7% over the same period.
Which raises the obvious question of whether DC plans should just use all index funds. In an exclusive interview with a high level BlackRock executive, which has both index and active funds, the question was asked and answered as follows:
Typically plan sponsors are looking to be efficient, so have fees in the mix, but there are also other factors they’re looking at in terms of being able to navigate to certain outcomes, and that’s really what starts to lead you towards active or passive. There are certain asset classes where people may have lower confidence that active managers can outperform.
So whether index or active funds, plan sponsors should look for the lowest cost share class applicable for their plan. Not only does it make sense for investors, it’s the fiduciary responsibility of plan sponsors to ensure that fees are reasonable.
