The Persistence of Risk-Adjusted Mutual Fund Performance

There is overwhelming evidence that, post expenses, mutual fund managers on average underperform a combination of passive portfolios of similar risk. The recent increase in the number and types of index funds that are available to individual investors makes this a matter of practical as well as theoretical significance. Numerous index funds, which track the S&P 500 index or various small-stock, bond, value, growth, or international indexes, are now widely available to individual investors. These same choices have been available to institutional investors for some time. Given that there are sufficient index funds to span most investors’ risk choices, that the index funds are available at low cost, and that the low cost of index funds means that a combination of index funds is likely to outperform an active fund of similar risk, the question is, why select an actively managed fund?