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.