Averages are “easy” and objective, but a new report finds that by using two simple filters – mutual funds with lower fees from the five largest fund families by assets – the average actively managed U.S. large-cap equity fund outperformed its benchmark in 2015, while the average subset of passive index fund slightly trailed its benchmark.
The research, by Fidelity Investments, notes that these filters have been remarkably consistent in identifying sets of funds with above-average relative performance over time, going on to explain that, for rolling three-year returns, the average actively managed fund selected by both filters beat the industry average 98% of the time.
Fidelity says that after applying those filters, the average actively managed U.S. large-cap equity fund outperformed its benchmark, after fees, by 70 basis points, and that this same subset of funds also outperformed their benchmarks by 0.18% per year from 1992 through 2015. Alternatively, the average subset of passive index fund slightly trailed its benchmark by 0.04%,
Why Those Filters?
The fee filter selects funds in the lowest 25% of reported expense ratios for each fund type (active or passive). Fidelity notes that funds with lower total expense ratios are able to deliver more of their gross returns to investors after fees, and because fees are clearly disclosed, investors can use this information to help them select funds.
For 2015, the average filter cutoff for the lowest-fee funds was 79 basis points for actively managed funds, and 11 basis points for passive funds.
The size filter focuses on assets under management (AUM), considering AUM to be a reasonable proxy for scale. For active funds, the filter selected funds from the mutual fund families with the most assets in active U.S. large-cap equity funds, because larger fund companies could use size to their advantage by committing more resources to research and trading, and the benefits of those resources can be shared across all the companies’ active U.S. large-cap funds.
For passive index funds, the filter selected the top 10% of funds by size in order to confer a similar selectivity and potential advantage.
At the end of 2015, the median amount of actively managed U.S. large-cap assets for all fund families was around $243 million, while the median for the top five fund families was more than $180 billion – more than 740 times larger. The report goes on to note that the largest five fund families held approximately 49% of the industry’s assets, while the smallest 50% of fund families (173 of 345) held less than 0.5% of AUM. As a result, the report explains that any average analysis of the entire industry will include a high proportion of active fund families that may lack comparable resources to compete.
Other Active Standouts
Fidelity’s research also reveals that in the other largest equity fund categories (international large-cap and U.S. small-cap) active managers had a better record of outperforming their benchmarks even without applying the two simple filters. Actively managed international large-cap funds outperformed their benchmarks by 0.85% per year and U.S. small-cap funds outperformed their benchmarks by 0.99% per year.
Fidelity – which certainly has skin in the active management side of the debate – notes that the active/passive debate focuses on the industry as a whole and the performance of the average active manager.
