Over the past three years, while about half of actively managed funds outperformed their respective Morningstar indexes, only 37 percent did on a risk-, size-, and style-adjusted basis. The numbers hold up similarly for five and 10-year returns. Furthermore, in some cases, the extra risk didn't justify the returns earned, said Russ Kinnel, director of mutual fund research at Morningstar.
What does this mean for investors? "Generally, a low-cost index fund, on a risk-adjusted basis will outperform an actively managed fund. So there should be a compelling reason for going with active management because the odds are against you. There should be a high bar for actively managed funds," said Kinnel.
An attractive actively managed fund, says Kinnel, would be one for which the fundamentals are strong, the cost is low and the managers have a proven track record of outperforming index funds. And It goes without saying that the fund should suit your goals, time horizon and risk tolerance. The question, though, is whether you could consistently identify such a winner, when about two-thirds of active funds will lose to index funds. Probably not.
"I'm not saying it can't be done, but most people are probably better off with index funds, particularly if they don't have a lot of time to devote to looking after their investments," said Kinnel.
"Enlist the help of an investment professional who has the resources to select and monitor a mutual fund portfolio," suggested Eric Lybarger, owner of Evergreen Investing. "They may also be able to purchase shares of mutual funds without having to pay the sales charges that may normally be associated with them. By eliminating these charges, a mutual fund investor may improve their chances for having an outperforming asset."
Don't Forget Diversification
What's the bottom line? Are actively managed funds worthy of your hard earned money? It depends. "One benefit of an actively managed fund is its element of specialty. For example, socially responsible investing is a way some clients choose to go who prefer investing in companies that adhere to their values. This can tailor your investment practices to who you are as an investor on a more qualitative basis," said Anthony Diaz, vice president of investments at IFC Advisory.
Then too, buying the S&P 500 index or the Russell 2000 Index does not mean you are truly diversified. "To be diversified you should have a mix of stocks, bonds and alternative investments that have a low correlation to the stock or bond market, such as real estate, gold and silver," pointed out certified financial planner Chad Olivier. With managed funds, you can invest in funds that have a balanced strategy, where the fund manager maintains a 60 percent stocks to 40 percent bond mix, with little deviation from it, he adds.
Perhaps an argument could be made for a combination of index and actively managed funds. Says Diaz: "Why put all your eggs in one basket. Get the best of both worlds."