Cheaper is Not Better: On the Superior Performance of High-Fee Mutual Funds

Abstract

The well-established inverse relation between fees and net-of-fee performance of active mutual funds guides portfolio decisions of many investors. We find that this relation is an artifact of the failure to adjust performance for exposures to profitability and investment factors. High-fee funds specialize in stocks with low operating profitability and high investment rates. We show that after controlling for exposures to profitability and investment factors, high-fee funds significantly outperform low-fee funds before expenses and perform similarly after expenses. Our results have important implications for household finance and support the theoretical prediction that skilled managers extract rents by charging high fees.

Keywords: Mutual fund performance, expenses, fee-performance relation, factor models

JEL Classification: G23, G11, J24