July 9th, 2012 at 7:57am by Tom Lydon
Traditional open-end mutual funds do not have the best track record when it comes to market-capitalization oriented options, with the majority of active managers underperforming indices. However, exchange traded funds passively track underlying benchmarks and provide a straight forward investment strategy.
An industry report from late 2011 calculated that about two-thirds of large-cap mutual funds underperformed their equivalent benchmarks over the last three years, writes Ryan C. Fuhrmann for Investopedia. Small-caps were the best category, but 63% of managers still underperformed. [Are Small-Caps a Better Emerging Market ETF Option?]
Given the high rate of underperformers, investors may be better off using market-capitalization ETFs. ETFs try to passively reflect the performance of a benchmark index – if the index increase by a certain percentage, the ETF will closely mirror the same percent gain. [ETFs vs. Index Funds]
Fuhrmann also notes that the high expense ratios may also attribute to the mutual funds’ underperformance, especially in small-cap funds where expenses tend to run higher. For instance, the majority of mutual funds have expense ratios above 1%, with some as high as 1.65%. In comparison, the average ETF industry expense ratio is about 0.55%.
Broad Index-based ETFs usually fall on the low end of the expense ratio spectrum. Examples include:
- iShares S&P 500 Index (NYSEArca: IVV): 0.09% expense ratio
- iShares Russell 2000 Index (NYSEArca: IWM): 0.26% expense ratio
- iShares S&P SmallCap 600 (NYSEArca: IJR): 0.20% expense ratio
- Vanguard SmallCap ETF (NYSEArca: VB): 0.16% expense ratio
For more information on small-capitalization funds, visit our small-cap ETFs category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.