Canadian Investment Review

Do High-Fee Mutual Funds Perform Better?

Written by Caroline Cakebread on Tuesday, September 19th, 2017 at 2:09 pm

caterpillarIn today’s low return environment, the focus has been put squarely on fees as investors look to squeeze the most of out of their investments.

But if you think keeping costs low is the best path to better returns, it might be time to think again.

That’s according to a new paper called, “Cheaper Is Not Better: On the Superior Performance of High-Fee Mutual Funds” by Jinfei Sheng, Mikhail Simutin, and Terry Zhang. It was presented this past weekend at the 2017 Northern Finance Association Conference, where Canadian Investment Review is proud to be a media sponsor or three years in a row.

While there have been many well-established arguments for the negative relationship between expense ratios and future net-of- fees performance for actively managed equity mutual funds, most research fails to adjust performance for exposure to the profitability and investment factors.

In the case of high-fee funds, they tend to exhibit a strong exposure to stocks with low operating profitability and high investment rates – characteristics associated with low expected returns.

The authors control for this in their own research and come up with an interesting finding: that high-fee funds significantly outperform low-fee funds before expenses, and perform equally well net of fees.

As the authors show: “factor models used to establish the prior fee-performance results are inadequate to control for differences in performance of funds with different fees. High-fee funds exhibit a strong preference for stocks with high investment rates and low profitability, characteristics that have been recently shown to associate with low expected returns. The commonly used three- and four-factor models produce large negative alphas for these types of stocks, leading to a premature conclusion that high-fee funds underperform net of expenses.”

You can read the full paper here on the NFA 2017 Conference Site.

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