The Real Reasons Why U.S. Mutual Funds Don’t Beat Their Index

The promise of future outperformance is a staple of active management*.  Year after year of underperformance, managers sell investors a bill of goods on why the upcoming year is a better environment for stock pickers.  Their promises rarely come to fruition.  How did active managers lose their seat at the head of the table to index funds/ETFs? 


Active Mutual Fund Expense Ratios–  the average equity mutual fund expense ratio has come down about 15% from 2003, but are still way too high (~1.25% per year).  Compared to the average exchange traded fund expense of .44% active counterparts have much more room to cut fees.


Number of Publicly Traded Companies is Shrinking– the opportunity set for generating excess return is getting smaller and smaller in the United States.  The Wilshire 5000 Index had 7,562 companies listed in 1998.  That number stands  at ~3,607 companies today. 


Sharks Are Getting Smarter– quantitative models, algorithms, CFAs/MBAs, artificial intelligence compete for excess return.  Generating excess investment returns is a zero sum game i.e. there are winners and losers.


Instant Information via Social Media/Internet– information is instantly available to the investing public eliminating (most) price anomalies that used to exist.


Pure Portfolios believes active management has a place, but paying a premium for the promise of outperformance is not a viable strategy.  We have followed the lead of some of the world’s largest pension and sovereign wealth funds which “in-source” the investment management.  This means building core positions using low cost index/exchange traded funds and using our own propriety individual stock and bond strategies (at zero ongoing cost of owning the assets to Pure Portfolios clients).  The annual cost savings of stripping out mutual funds provides a ~1% head start in the quest to generate reasonable investment returns for our clients.


If you want to learn more about how Pure Portfolios expresses our strategic views while keeping costs low, please reach out via PurePortfolios.com.


*Active management (also called active investing) refers to a portfolio management strategy where the manager makes specific stock bets with the goal of outperforming a benchmark index (many mutual funds are actively managed).

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