Expense ratios and returns for stock and bond mutual funds

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
Beliavsky
Posts: 932
Joined: Sun Jun 29, 2014 10:21 am

Expense ratios and returns for stock and bond mutual funds

Post by Beliavsky » Sat Jan 05, 2019 7:12 pm

Double Whammy: High-Fee Mutual Funds Do Worse
By Derek Horstmeyer
Wall Street Journal
January 4, 2019 2:34 p.m. ET
...

I looked at all actively managed mutual funds that trade in the U.S., comparing the average return of high-fee funds (those with an expense ratio over 1.5%) with the average return of low-fee funds (all funds with expense ratios under this level). It painted a pretty negative picture of the high-fee options.

Consider the performance difference between high-fee and low-fee active funds focused on large-cap U.S. stocks. Over the past 10 years through the third quarter of 2018, the average high-fee option delivered an average annual return of 10.61% after expenses, while the low-fee option averaged 12.26%—a difference of 1.65 percentage points and a substantial advantage for the low-fee option.

...

An exception to the vast underperformance of high-fee mutual funds may be fixed-income mutual funds. While high-fee fixed-income funds still on average underperform their low-fee counterparts by 0.18 percentage point based on the 10-year horizon, a good number of these high-fee funds outperform the low-fee options, and they do it consistently over time.

User avatar
jeffyscott
Posts: 8069
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: Expense ratios and returns for stock and bond mutual funds

Post by jeffyscott » Sun Jan 06, 2019 8:37 am

I would think that US stock funds that are charging 1.5%+ must be broker sold "C" shares, where 1% of that is compensating the broker?

In any case, 1.5% seems like an insanely high dividing line between "high" and "low" fee funds. The asset weighted average for active funds is about 1/2 that: https://www.morningstar.com/blog/2018/0 ... study.html
Time is your friend; impulse is your enemy. - John C. Bogle

garlandwhizzer
Posts: 2391
Joined: Fri Aug 06, 2010 3:42 pm

Re: Expense ratios and returns for stock and bond mutual funds

Post by garlandwhizzer » Sun Jan 06, 2019 12:41 pm

Bellavsky wrote:

An exception to the vast underperformance of high-fee mutual funds may be fixed-income mutual funds. While high-fee fixed-income funds still on average underperform their low-fee counterparts by 0.18 percentage point based on the 10-year horizon, a good number of these high-fee funds outperform the low-fee options, and they do it consistently over time.
The reason why high fee fixed income outperformed over the last decade is that they took on more risk in the bond market. We've basically had a 10 yr. equity bull market with ever increasing corporate profits which rewarded the higher yielding but riskier segments of the bond market such as HYB and less than investment grade corporates. Taking on increased risk in such a scenario increases return and can more than offset the higher fees charged. The bond market is efficient at pricing risk and it is reasonable to assume that anything yielding more in fixed income carries with it greater risk. Those great results over the past 10 years for high fee fixed income funds will disappear and reverse when the economy goes into recession. The main portfolio purpose of fixed income is neither yield nor total return but rather to be a safe port in an equity bear market. These high fee funds with good 10 year backtesting results will fail that test when it comes. That's when the other side of risk shows up. This is yet another example of why backtesting and data mining tells you all about the past and but is often misleading about the future. It accurately portrays the future in fine detail only if it is exactly like the past and no one expects the fixed income market going forward to be exactly like the past decade.

Garland Whizzer

User avatar
grabiner
Advisory Board
Posts: 24829
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Expense ratios and returns for stock and bond mutual funds

Post by grabiner » Tue Jan 08, 2019 10:53 pm

garlandwhizzer wrote:
Sun Jan 06, 2019 12:41 pm
Bellavsky wrote:

An exception to the vast underperformance of high-fee mutual funds may be fixed-income mutual funds. While high-fee fixed-income funds still on average underperform their low-fee counterparts by 0.18 percentage point based on the 10-year horizon, a good number of these high-fee funds outperform the low-fee options, and they do it consistently over time.
The reason why high fee fixed income outperformed over the last decade is that they took on more risk in the bond market. We've basically had a 10 yr. equity bull market with ever increasing corporate profits which rewarded the higher yielding but riskier segments of the bond market such as HYB and less than investment grade corporates. Taking on increased risk in such a scenario increases return and can more than offset the higher fees charged.
In particular, most bond index funds hold far more Treasuries than general bond funds do. Total Bond Market Index, for example, outperforms most general bond funds when Treasuries outperform corporates; this often happens when you most need your bond fund's diversification, such as in the fall of 2008.

If you compare investment-grade corporate bond funds only, the low-cost funds should come out ahead. Vanguard Intermediate-Term Corporate Bond Index (available as an ETF VCIT), tracking an index of investment-grade corporate bonds, has above-average returns among corporate-only funds at Morningstar, despite apparently having a shorter duration than its category (and thus less risk, as it outperforms the category average when rates rise and bond prices fall).
Wiki David Grabiner

User avatar
jeffyscott
Posts: 8069
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: Expense ratios and returns for stock and bond mutual funds

Post by jeffyscott » Wed Jan 09, 2019 10:19 am

grabiner wrote:
Tue Jan 08, 2019 10:53 pm
If you compare investment-grade corporate bond funds only, the low-cost funds should come out ahead. Vanguard Intermediate-Term Corporate Bond Index (available as an ETF VCIT), tracking an index of investment-grade corporate bonds, has above-average returns among corporate-only funds at Morningstar, despite apparently having a shorter duration than its category (and thus less risk, as it outperforms the category average when rates rise and bond prices fall).
M* categories for bond funds are strange. They put most intermediate bond funds that tend to concentrate in corporate bonds (or at least have minimal treasuries) in the intermediate bond fund category. Then they have this corporate bond fund category that, for whatever reason, some bond funds go in with no division by duration.

Examples, Vanguard Interm-Term Investment Grade (VFIDX) and long term investment grade (VWETX) are both in the corporate bond fund category. But short term investment grade falls in the short term bond category. Funds that I think are comparable to VFIDX, that have only 10-12% treasuries, are put in intermediate term bond fund category.

If you screen for corporate bond fund M* comes up with just 57 (with distinct portfolio selected), while intermediate category has 291.

Anyway, agree that low cost funds will come out ahead, but I do not limit myself to funds in the M* corporate bond fund category when looking for low cost bond funds that do not concentrate in treasuries, like the general bond index funds do.
Time is your friend; impulse is your enemy. - John C. Bogle

User avatar
grabiner
Advisory Board
Posts: 24829
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Expense ratios and returns for stock and bond mutual funds

Post by grabiner » Wed Jan 09, 2019 8:12 pm

jeffyscott wrote:
Wed Jan 09, 2019 10:19 am
grabiner wrote:
Tue Jan 08, 2019 10:53 pm
If you compare investment-grade corporate bond funds only, the low-cost funds should come out ahead. Vanguard Intermediate-Term Corporate Bond Index (available as an ETF VCIT), tracking an index of investment-grade corporate bonds, has above-average returns among corporate-only funds at Morningstar, despite apparently having a shorter duration than its category (and thus less risk, as it outperforms the category average when rates rise and bond prices fall).
M* categories for bond funds are strange. They put most intermediate bond funds that tend to concentrate in corporate bonds (or at least have minimal treasuries) in the intermediate bond fund category. Then they have this corporate bond fund category that, for whatever reason, some bond funds go in with no division by duration.
The corporate category is new. M* used to have only government and general, all dividend by term, and then specialty categories (ultrashort, high-yield, convertible, bank-loan). This put all-corporate funds and corporate-government funds together. The result was that Vanguard's investment-grade funds came out at the top and general index funds below average when corporate bonds outperformed Treasury bonds, and the reverse when Treasuries outperformed.
Wiki David Grabiner

Topic Author
Beliavsky
Posts: 932
Joined: Sun Jun 29, 2014 10:21 am

Re: Expense ratios and returns for stock and bond mutual funds

Post by Beliavsky » Fri Jan 11, 2019 12:03 pm

Related article:

For a While, Bond Funds Were an Exception to the Indexing Rule
By Carla Fried
New York Times
January 11, 2019

...

Over the last decade, as the United States government has issued more and more debt, Treasuries have grown from 22 percent of the index (and index funds) to 40 percent. The index’s Treasury stake is likely to increase in the coming years because the new tax law has reduced corporate tax revenue and a growing federal budget deficit will require more Treasury debt to pay the country’s bills.

The average active core manager has 17 percent invested in Treasuries, according to Morningstar Direct. Among the largest actively managed funds, MetWest Total Return has the biggest stake, at 19 percent. Pimco Total Return and Dodge & Cox Income have less than 15 percent invested in Treasuries. DoubleLine Total Return’s stake is below 5 percent.

Snubbing low-yielding Treasuries and investing in higher-yielding corporate and securitized bonds — and, in some instances, international and emerging market bonds — has paid off during the extended economic recovery. Moreover, Treasuries often take the biggest hit when interest rates rise. And that has been the script lately; the yield on the 10-year Treasury note has risen from 1.6 percent in the summer of 2016 to 2.7 recently.

But Larry Swedroe, director of research at Buckingham Strategic Wealth and author of “The Only Guide to a Winning Bond Strategy You’ll Ever Need,” suggests that a longer-term perspective is needed.

“Treasuries are exactly what bond investors should want to own,” he said. “When stocks get hammered, Treasuries tend to go up in value, in the flight to quality. Other bonds don’t.”

...

Post Reply