In real estate, the mantra is “location, location, location.” In investing, one mantra is—or should be—“cost, cost, cost.”
Year-to-date through Dec. 8, the average large-cap core mutual fund rose 10.5%, lagging the S&P 500's 12.2%, according to CFRA. Such underperformance is not new, as the SPIVA scorecard confirms that it's been nine years since the average large-cap core fund was stronger.
In 2015, the average active fund lagged by 212 basis points. Such performance challenges are due in part to the 1.1% net expense ratio incurred by these mutual funds.
In CFRA’s proprietary mutual fund and ETF ranking systems, cost is one of three primary inputs (performance and risk are the others) separating the wheat from the chaff.
Mutual Funds Vs. ETFs
The above comparisons may seem unfair, since index returns are based on no such fees. So here’s an apples-to-apples comparison: mutual funds versus ETFs. Indeed, thanks to iShares, investors can get large-cap index exposure with the iShares Core S&P 500 ETF (IVV) for just 4 basis points; IVV was up 12.2% year-to-date, in line with the index it seeks to track.
In contrast, the BlackRock Large Cap Core Fund (MDLRX) is an actively managed large-cap core offering that has a moderately higher-than-average 1.14% net expense ratio. The fund was up 10.7% year-to-date through Dec. 8, and also underperformed the S&P 500 in 2014 and 2015. You can see below the higher fees for mutual funds limited the gains.
Sources: CFRA, Thomson Reuters Lipper, as of Dec. 8, 2016
As one would hope from active management, the fund is distinct from the index and holds approximately 80 stocks. At the end of October, it was overweighted to health care and info technology, while underweighted to industrials. In addition, it has no exposure to real estate or telecom services stocks.
CFRA is bullish on the industrials sector, believing many securities have strong fundamentals and still attractive valuations. At 8 basis points, the Fidelity MSCI Industrials Index ETF (FIDU) has the lowest expense ratio among the wide array of sector ETFs. FIDU is a market-cap-weighted offering, so General Electric (GE) and 3M (MMM) are 11% and 4% of the fund’s assets, respectively.