Investible Benchmarks for Actively Managed Mutual Funds

Abstract

I use exchange traded funds to construct low cost benchmarks for actively managed mutual funds. The benchmarks can be identified in advance, require no leverage or shorting, and require only annual rebalancing. The average fund underperforms its benchmark by 1% per year after expenses, a difference in performance equivalent to a $25 billion per year opportunity cost for investors selecting active management. The fees charged by actively managed funds are the primary reason they underperform. Active management comes at a significant cost, but without any offsetting benefit.

Keywords: Mutual Funds, Benchmarks, Alpha, Expenses, Active, ETF

JEL Classification: G11