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Test methodology

The sample includes all active US equity open-end mutual funds over the period from February 1980 through February 2009. Index, lifecycle, target date, allocation, balanced, and 529 funds are excluded. This results in a sample of 4070 funds, with half still in existence in February 2009, for a total of 403,577 fund-month observations. The sample is survivor bias free since it includes all active US equity funds that existed in any month during this sample period. Excess monthly returns are net of the monthly S&P 500 return as well as automatically deducted management, trading, 12B-1 and other fees. Reported results are simple averages across funds. Monthly fund returns were obtained from Thomson Financial.

The first test examines the compound monthly net excess return performance of the average active US equity fund. The results reported in Figure 1 below are organized by fund year, that is, the number of years since the inception of the fund. It reveals that the average compound monthly return is -5 basis points for fund years 1 through 5 and declines to -13 basis points for fund years 26 through 30. This is consistent with a number of studies that show the average fund underperforming, with performance declining with age. Furthermore, the underperformance of the typical 26-30 year old fund is roughly equal to the average monthly management fee of 11 basis points, which implies that, before fees, such funds earn index returns.

These conclusions are further supported by the results shown in Figure 2 below. The percent of funds beating the S&P 500 drops from 44% for fund years 1 - 5 to 33% for fund years 26 - 30. That is, a majority of active funds fail to beat the market, while performance worsens with fund age. Thus investing in active managers requires something beyond simply buying and holding a fund over time.

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