Exchange traded funds (ETFs) track indexes for better or worse, but as of late, mutual funds have mostly been beating the indexes. Most mutual funds notoriously underperform their benchmarks, but with this shift, we might be sharpening our knives for a plate of crow. Or are we?
According to Lipper Inc., 95% of intermediate bond funds beat the Barclays Capital U.S. Aggregate Bond Index and 68% of diversified U.S. stock funds beat the Standard & Poor’s 500-stock index in 2009, reports Jason Zweig for The Wall Street Journal. Year-to-date, 58%of stock and bond funds are beating their underlying benchmarks. [Making the Switch from Mutual Funds to ETFs.]
However, Zweig explains how indexes don’t always reflect what fund managers are doing. For instance, the Barclays Aggregate’s market average gained 6% in 2009, whereas most taxable investment-grade bond funds were up 14%. The reason for the discrepancy was because the index consists of bonds issued by the U.S. Treasury and government-related equities while corporate bonds make up only 18% of total benchmark.
The average intermediate-term bond fund holds half its assets in government bonds, almost 40% in corporates and 10% in foreign debt. The reason why funds deviate from their indexes with riskier holdings is because funds charge expenses, and a fund with a 1% annual cost has to beat the index by at least 1% to justify fees.
Furthermore, the United States has issued around $2 trillion in new debt to bail out the financial system, which has pushed up the percentage of Treasuries to more than 29% of the index, compared to 22% at year-end 2007.