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Will Your Mutual Fund Outperform?

Investors are faced with a choice between more than 8,300 distinct mutual funds (excluding multiple share classes of the same fund), according to data from Morningstar. How can mutual fund investors be expected to choose wisely from such a large investment universe? As it turns out, the first step may well be to filter out all actively-managed mutual funds.

Standard & Poor’s, a leading financial market benchmarking firm, prepares a semi-annual analysis called the S&P Indices Versus Active Funds Scorecard, or SPIVA Scorecard. The Scorecard seeks to compare the performance of various mutual funds to relevant benchmarks tracked by S&P. The Scorecard is particularly useful for the following reasons:

  1. S&P considers all funds available at the beginning of a sample period, and not just those funds which survived through until today, thereby eliminating survivorship bias.
  2. The Scorecard compares each mutual fund to a relevant benchmark, as opposed to comparing all funds to a single benchmark such as the S&P 500.
  3. S&P provides analysis on an asset-weighted basis, which reflects the fact that an investor is more likely to have access to, say, the American Funds Washington Mutual Fund ($90 billion in assets) than the Ranger Small Cap Fund ($23 million in assets).

For the period ending 12/31/2016, the SPIVA Scorecard showed that on a 5-year trailing basis, between 80% and 97% of US equity mutual funds were outperformed by a relevant S&P index. This means that even in the best-performing category of US equity mutual funds (those in the Multi–Cap Value space), only 20% of funds outperformed their benchmark. This lends strong evidence to the wisdom of utilizing index funds (rather than actively-managed funds) to assemble a portfolio.

We find two common objections to the advice to avoid actively-managed funds – the first is to only use actively-managed funds in the “less-efficient” asset classes, such as small-company stocks or emerging markets stocks. However, the SPIVA Scorecard confirms that active-manager underperformance is as robust in these asset classes as it is in more common asset classes such as large-cap US stocks. The second objection we hear is that investors should limit their choice of actively-managed funds to those with good track records. Fortunately, SPIVA’s methodology addresses this point in its Persistence Scorecard, which shows that “only 4.47% of large-cap funds, 3.68% of mid-cap funds, and 9.27% of small-cap funds maintained top-half performance over five consecutive 12-month periods. Random expectations would suggest a repeat rate of 6.25%.”

We urge investors to carefully consider that costs (mutual fund fees, sales charges, advisor fees, etc.) and risk (asset allocation) are the two portfolio characteristics that are within your control, and to devote the bulk of your effort to focusing on this factors. Choosing the best mutual fund manager will likely prove to be an exercise in futility.

Dan_BDaniel Bauer, CFP® serves as the Chief Investment Officer of AllSquare Wealth Management, LLC. In this capacity, his responsibilities include developing, implementing, and monitoring investment portfolios for customers of the firm.


AAllSquare Wealth Management is a Federally Registered Investment Advisory Firm.
AllSquare Wealth Management, LLC is a registered investment adviser.


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