Past performance still beats fees when it comes to mutual fund selection.
Despite several ongoing studies showing that fees are among the best fund selection tools and the conventional wisdom that past performance is no guarantee of future results, mutual fund investors still use historical performance to select their investments, according to a recent report from the Investment Company Institute (ICI).
In the ICI’s “Annual Mutual Fund Shareholder Tracking Survey,” a poll of 2,223 mutual-fund owning households conducted in mid-2017, almost all investors, 87 percent, said that they looked at historical performance and performance relative to a benchmark index when choosing a mutual fund, and half of mutual fund investors said that fund performance was very important to their decision.
Fees and expenses were the second most important measure when selecting a mutual fund, considered at least somewhat important by 79 percent of the survey respondents, and very important by 40 percent.
Nevertheless, mutual fund investors tend to pay lower-than-average expense ratios on their portfolios. While the average mutual fund carries a 1.25 percent annual expense ratio, the average mutual fund investor pays just 0.59 percent on assets annually as measured by an asset-weighted average expense ratio. As more investors focus on lower-cost funds, the asset-weighted expense ratio should decline faster than the industry average.
In recent research from fund analysts at Morningstar and asset managers like the Capital Group, fees were found to be one of the most reliable factors in selecting high-performing mutual funds, with a 2016 Morningstar study finding that funds in the cheapest fifth of the mutual fund universe were three times as likely to survive and outperform their benchmarks as the most expensive fifth of the mutual fund universe.
Other analysis of the fund universe, this time from the S&P Dow Jones Indices’ annual SPIVA U.S. Scorecard and its Persistence Scorecard, has repeatedly shown that past performance cannot predict future returns. Mutual fund outperformance is sporadic and inconsistent, and high-performing managers tend to lose their luster, even over short time periods.
Almost three-quarters of the respondents in the ICI survey also found a comparison between a mutual fund’s performance and its benchmark at least somewhat important to the selection process, while 58 percent felt the same about mutual fund ratings and analysis from a ratings service.
Most mutual fund investors consider both a fund’s objective and the risk level of its recently reported holdings when selecting investments, according to the survey. Nearly 40 percent of households said that risk and objective were very important to their fund selection.
Mutual fund investors were more likely to be risk-takers than the general population, ICI said. While a broader survey of 5,000 U.S. households found that only 22 percent were willing to take above-average or substantial risk for above-average gains, 34 percent of the 2,223 mutual-fund-owning households would make the similar risk-return trade-offs. Just 20 percent of mutual fund owners said they would prefer to take below-average risks or no risk at all, while a much higher 46 percent of those in the broader survey said they’d take less or no risk.