Measuring the True Cost of Active Management by Mutual Funds
Journal of Investment Management, Vol. 5, No. 1, First Quarter 2007
Posted: 28 Mar 2007
This article derives a rigorous method for allocating fund expenses between active and passive management and that enable one to compute the implicit cost of active management. Computing this "active expense ratio" requires only a fund's published expense ratio, its R-squared relative to a benchmark index, and the expense ratio for a competitive fund that tracks that index. This method is then applied to the Morningstar universe of large-cap mutual funds and active expense ratios are found to average more than 7%. The cost of active management for other classes of mutual funds is also found to substantial.
Keywords: Mutual fund expense ratios, active portfolio management, shadow indexing, mutual fund performance
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