Double Whammy: High-Fee Mutual Funds Do Worse

Fund managers who charge more than their peers often aren’t worth the extra cost, an analysis suggests

For investors who pay a high fee to mutual-fund managers, the obvious question is: Are the fees worth it?

The answer, unfortunately, is often no.

Data show that actively managed mutual funds with relatively high expense ratios—yearly fees as a percentage of assets under management—are associated with some of the worst performing and most poorly managed funds, especially in the U.S.-stock category.

In addition to poor performance, these high-fee funds are also associated with elevated levels of risk and excessive portfolio turnover. The high-fee U.S. large-cap mutual funds had average volatility (swings in price, calculated using monthly fund returns and expressed as a percentage) of 11.54% over the past two years, while the low-fee option came in at 10.23% over the same period. Equally troublesome is that the asset turnover at these high-fee funds is nearly double that of the low-fee funds. On average, high-fee funds sell or buy 67% of their assets under management in a given year, vs. 35% for their lower-fee peers. 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.

Finally, according to Morningstar Stewardship ratings, high-fee funds are also more likely to be associated with poor governance practices—regulatory issues, poor managerial incentives and practices such as charging hidden fees (front-end fees, back-end fees, 12b-1 fees). Indeed, the more expensive funds have a 30% greater chance of receiving a failing governance rating from Morningstar than do their lower-fee peers.

 .. An exception to the vast underperformance of high-fee mutual funds may be fixed-income mutual funds. While high-fee fixed-income funds still on average underperform their low-fee counterparts by 0.18 percentage point based on the 10-year horizon, a good number of these high-fee funds outperform the low-fee options, and they do it consistently over time.