Fees are not the only reason that actively managed funds often underperform passive index funds, as commonly believed. According to the latest SPIVA Institutional Scorecard report from S&P Dow Jones Indices, at least two-thirds of mutual funds and institutional accounts in multiple asset classes underperformed their respective benchmarks even before fees were included in the calculation.

Eighty percent of domestic mutual funds underperformed the S&P 500 before fees were calculated – a calculation the report calls “gross-of-fees.” After fees, also known as net-of-fees, the number jumped to 88%.

For institutional equity accounts — defined as separately managed accounts or co-mingled trusts – the underperformance rate was 85% before fees (there was no net-of-fees calculation for those accounts).

“By comparing retail mutual funds and institutional accounts on a gross-of-fee basis against their respective benchmarks, we eliminate any possibility that fees are the sole contributor to a given manager’s underperformance,” the report explains.

All the performance percentages were based on the annual returns of funds and institutional accounts over the five years that ended Dec. 31, 2015.

Among domestic equity funds one of the most surprising findings was the relative underperformance of small-cap funds, a sector that’s often touted as inefficient and therefore an area where active managers can make a positive difference.

Eighty-one percent of small-cap mutual funds and institutional accounts underperformed the S&P SmallCap 600 benchmark before fees. A whopping 90% of mutual funds underperformed after fees.

 “Domestic equity funds have a tough time beating benchmarks probably because those markets are so efficient,” says Aye Soe, senior director, Global Research & Design.

The one equity category that benefitted from active management, according to the report, was real estate, but even there the benefit was limited. While only 27% of institutional accounts underperformed the S&P U.S. REIT benchmark, 52% of retail mutual funds did, and after fees that number jumped to 83%.

The picture was also brighter for actively managed international equity funds, though not for emerging market funds, and for some domestic and foreign bond funds.

Before fees 29% of international equity institutional accounts and 42% of international equity retail funds underperformed the S&P 700 index, which consists of large-cap foreign stocks. After fees, however, more than half – 55% – of retail international funds underperformed.

The performance of emerging market equity funds was even weaker. Half of the institutional accounts and 55% of retail funds (before fees) in this asset class underperformed the S&P Emerging BMI index. After fees, just 70% of retail funds did.

Among bond funds, institutional accounts had the edge, with fewer than 30% of investment grade and mortgage-backed funds underperforming their respective benchmarks.

The comparable numbers for retail funds were closer to 35% before fees but 42% after fees for intermediate investment grade and 64% after fees for mortgage-backed debt funds.

Fees also had a heavy impact on the performance of retail muni bond funds. Just 14% of general municipal debt funds underperformed the S&P National AMT-Free Municipal Bond Index before fees, but after fees that percentage jumped to 43%.

“In fixed income, a lot of returns are eaten up by fees,” says Soe.

That was also apparent with high-yield funds, which contrary to popular belief also did not benefit from active management. More than half of those funds underperformed the Barclays US Corporate High Yield Index before fees, and 79% underperformed after fees. Among institutional high-yield accounts, 47% underperformed the index.

Active management also failed to lead to strong performance for emerging market bond funds, another asset class popularly thought to benefit from active management.

Eighty-three percent of retail emerging market bond funds failed to beat the Barclays Emerging Markets index, before fees; the number rose to 94% after fees.

Among institutional managers the performance of emerging market debt accounts was mixed. While just half of those accounts investing in U.S. dollar-denominated emerging market corporate debt underperformed their benchmark, 98% of accounts investing in local currency-denominated emerging market government debt did “indicating the challenge of actively managing emerging market currency exposure,” according to the report.

How should advisors use all this data?

Soe says, “We’re not saying that investors should go all passive or all active management. If active management was truly bad then 100% of funds would outperform, but every year you can get at least 20% that do.“

Identifying that 20% is key.

“Do your homework,” says Soe. “Know which asset classes work best if active or passive.”

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