Fund costs give you the best clue for outperformance – Morningstar

The cheaper a fund is, the better the chance it outperforms its peer group, a study by Morningstar has shown.

Fund costs give you the best clue for outperformance – Morningstar

Morningstar’s study, focusing on US-domiciled active funds, found that those funds with lower expense ratios consistently outperform their more expensive peers across all asset classes Morningstar looked at (US equity; global equity, US bond and balanced funds). This was the case over both three- and five-year periods.

US equities showed the strongest relationship between fund costs and return. The funds in the lowest-cost quintile had an annualised return of 10.91% over five years, compared to just 8.88% for the highest-cost quintile. This is actually higher than the average cost difference between the lowest- and highest-cost quintiles (see chart).


ETFs – still the better option?

However, the returns of the funds in the lowest-cost quintile (which averaged 0.65%) were still lower than those of the S&P 500, which averaged 12.6% a year over the period. This suggests that buying an ETF would have worked even better than going for a low-cost fund.

Active US equity funds overall have struggled to outperform their benchmark recently. Since more expensive funds tend to be more active than their cheaper peers as well, as Morningstar suggests in its study, a possibility is that so-called benchmark huggers are well-represented among these lowest-cost funds advocated by Morningstar.

Russel Kinnel, manager research director at Morningstar, admits many of these lowest-cost funds actually could have a low active share. “It's possible there is a link because successful funds will often have larger portfolios and lower costs,” he says. However, being a benchmark hugger isn’t necessarily a bad thing, according to Kinnel. “Active share has no predictive power and many diversified funds have been able to beat their benchmark. High costs are a bad idea no matter the portfolio.”

The best approach would therefore be to screen for costs first and then see whether an ETF or an active fund suits better to reach your investment goals, says Kinnel. “Our research continues to find that fund fees are a strong and dependable predictor of future success.”

Click here to read Morningstar's study.  

Kames Income Hub


Vincent McEntegart, manager of the Kames Diversified Monthly Income Fund, explains how he aims to deliver a stable and sustainable income of 5% p.a.*, paid monthly, by investing in a range of asset classes

Square Mile Research

Matthews Asia Funds Asia Dividend
Matthews Asia Funds Asia Dividend...

Talking Factsheets is a video service for users...

Visitor's Comments Add your comment

Add Your Comment

We won't publish your address

About Author

Tjibbe Hoekstra

Senior Reporter

Tjibbe joined Expert Investor as a senior reporter in March 2014. Before moving to London he worked as a financial news reporter for various news outlets in Amsterdam, including Reuters and ANP, the main news agency in the Netherlands. He also worked for Fondsnieuws, a website and magazine for finance professionals in the Netherlands. Tjibbe holds a MSc in Public Administration and a post-graduate diploma in Journalism.



Investment Strategy




PA Channel Island 2016
PA Channel Island 2016

8th November 2016
The Royal Yacht, Jersey


17th November 2016
The Andaz

PA Emerging Markets 2016
PA Emerging Markets 2016

1st December 2016
The Mayfair, London

Sponsored Content

Investment Strategy