Management fees could be what is holding back active funds from outperforming passive funds that track a benchmark index.
According to a research paper, Fund Selection: Sense and Sensibility, Dutch and Belgian researchers looked at Luxembourg and Ireland-based Ucits, or Undertakings for the Collective Investment in Transferable Securities, equity and fixed-income funds from 2008 through 2020 and found that Europe-listed actively managed funds shares accessible to retail investors largely underperformed compared to institutional fund share classes due to the differences in associated management fees, the Financial Times reported.
Specifically, the researchers found that the active equity funds outperformed passive funds by an average of 0.56% per year before accounting for management fees.
Over 35 equity fund categories, including global emerging markets and U.K. large caps, the researchers discovered active funds outperformed 28 categories or 80% of the time, but they added that it was statistically significant for only six categories. Again, the outperformance was lower after accounting for fund fees.
In comparison, when looking at only institutional share classes, 25 categories or 71% of fund categories still outperformed after taking management fees into account.
“Active equity managers can outperform the passive alternative when fees are reasonable,” the paper’s authors said.
The research paper, though, noted that the case is “less supportive” when looking at fixed-income managers.
“Retail investors experienced negative net outperformance due to the level of fees across fixed-income categories,” according to the researchers.
When comparing active fund performances against passive fund performances in absolute terms, the researchers found active equity funds provided an average added value of €220,000 per year before fees for the retail share class. However, the researchers noted that retail investors usually don’t have the size or total wealth invested to benefit from this value add.
“Unfortunately, the retail investor — given the fees — could not benefit much from this active management skill since the average €410,000 in fees charged largely exceed the gross value added,” according to the paper.
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