Thursday, April 25, 2013

Do ETFs and Mutual Funds with Higher Fees Outperform?

By Tim Husson, PhD and Olivia Wang, PhD

There was a great comment on our post about FINRA's Mutual Fund Expense Analyzer.
Is there a positive correlation between fees and gross returns? In other words, are investors who pay higher fees compensated by higher returns?
On the one hand, one might expect that in order to garner high fees, a fund would have to earn higher returns; but on the other, it may be the case that higher fees simply erode profits and yield lower total returns.

We looked at data provided by Bloomberg on all US-domiciled ETFs.  We excluded a few outliers with very low reported fees (under 0.1%) or who did not provide data on either fees or 1 year total return.  The result was 1,020 funds, plotted below:
There does not appear to be a clear relationship between returns and fees--although there seems to be a negative correlation (supporting the idea that higher fees erode returns), the R-squared value is much too low to draw any conclusions. If we separate funds into quartiles based on their 1 year total return and average fees within each quartile, we see another negative relationship:  

But again, the scatter is enormous so the relationship is unclear.

We also looked at the 16 largest mutual funds by net asset value and compared their fees calculated using FINRA's tool (subject to data availability).  We assumed for this calculation an initial investment of $1,000 held for five years, and plot the total fees and sales charges over that period against the historical 5 year annualized total return of the fund:

Again, there is no clear relationship between returns and fees.  But it is interesting to point out the cluster of funds with high fees around 1-2% return are all from a single issuer, American Funds, and the cluster of funds with low fees but similar returns are all from Vanguard.

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