A recent article from MorningstarAdisor discusses an urban myth that mutual funds have hidden fees of 140-200 basis points (bps), which are omitted from expense ratios. In this context, the article provides the following statistics:

Over the trailing 10 years ending March 31, 2013, the average U.S. large-cap equity fund, on an asset-weighted basis, trails the market index by its expense ratio plus about 39 basis points. Over the past five years, this figure shrinks to 25 basis points.

This means that an average large-cap fund not only failed to earn its expenses but also subtracted value on top of them. By how much in total? The Investment Company Institute’s report provides the following asset-weighted statistics of expense ratios for equity funds:

All Funds Actively-Managed Funds Index Funds
2003 100 bps 110 bps 25 bps
2008 83 94 17
2012 77 92 13
10-Year Average 87 98 18
5-Year Average 82 95 15

So, an average large-cap equity fund subtracted about 98 + 39 = 137 bps and 95 + 25 = 120 bps per year in the 10-year and 5-year periods, respectively. The non-asset-weighted statistics of fund expense ratios are even worse (all figures for 2012):

Equity Strategy Median Mean
Aggressive growth 137 bps 147 bps
Growth 124 131
Sector 146 153
Growth and Income 112 118
Income 112 120
International 147 155
Average 133 141

Of note here is the right skew of the expense ratio distribution (in all cases, the mean is greater than the median). This implies that some funds have very high expense ratios. Indeed the 90th percentile of equity funds has an average expense ratio of 216 bps or more, which is over 62% higher than the median of 133 bps.

Apparently, all this was not lost on he California Public Employees’ Retirement System (CalPERS), which this week decided to replace actively-managed strategies with passive ones even for asset classes other than equities:

The $1.64 billion defined-contribution plans, including the $1.1 billion 457 plan, will be adding passively managed U.S. equity, international equity, short-term-bond, intermediate-term-bond and real-asset strategies from State Street Global Advisors.

The investment committee elected to drop actively managed U.S. small- and midcap value and growth strategies managed by The Boston Co. Asset Management LLC, international equity managed by Pyramis Global Advisors, short-term bond managed by Pacific Investment Management Co. LLC, and intermediate and Treasury inflation-protected securities strategies managed in-house.

Fees for the funds will drop to 6 basis points, from 52, because of the change.

Evidently, even with an average expense ratios of 52 bps (which is close to the 10th percentile for actively-managed funds), original strategies failed to earn their keep.

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