Here's good news for index-investing fans. Actively managed mutual funds have generally underperformed their corresponding benchmark indices over time, according to a study released in late March that analyzes 10 years of performance figures reported by Morningstar, the popular mutual fund tracker.
The report by Zero Alpha Group, an alliance of eight independent financial-planning firms that preach passive investment management, says real returns for the period are 1.6 percent lower on an annual basis than reported by Morningstar. The reason for the discrepancy is that Morningstar, and other trackers, eliminate the returns of mutual funds that have shut down. This so-called “survivor bias” overstates the contribution of the better-performing funds, generating artificially inflated numbers.
The study, Survivor Bias and Improper Measurement: How the Mutual Fund Industry Inflates Actively Managed Fund Performance, relied on quarterly data from Morningstar's Principia system, examining 42 categories over the 10-year period. Funds that were liquidated or merged with others were added back into calculations of performance for each of the categories.
“Actively managed mutual funds in all nine of the of the Morningstar Principia style boxes lagged their related indexes from 1995-2004,” states the report.
Don Phillips, a managing director at Morningstar, says that he doesn't dispute the report's numbers, but that there are many ways to calculate fund performance. “You could also do it by asset-weighting the averages,” which would factor in the size of certain funds, he says. Given the growth and dominance of a handful of fund companies, he adds, this would also be valuable to investors. For a related story on real real returns, see p. 30.
