Taxes and estates | I’m looking for Alpha

By Anu Ganti

One of the potential advantages of indexing is its typically lower cost relative to active management. Investors benefited substantially from the savings in fees. And as indexing expanded across asset classes, these rewards have worsened, especially in fixed incomewhere taxes may prove more influential.

In Figure 1, we see that the expense ratios of US index mutual funds have been consistently lower than their active counterparts over the past two decades. Although this gap has narrowed in recent years, we still see a fee differential of 60 bps between stocks and 41 bps between bonds starting in 2023.

In addition to the fee savings, investors tracking the index could also have benefited from avoiding active underperformance. Specifically in relation to the equity markets, our SPIVA® Scoreboards show that only a few actively managed mutual funds exceeded the reference level. But how do we account for institutional investors who, unlike retail investors, claim an advantage in selecting savvy asset managers along with a better vantage point to negotiate fees?

Our SPIVA Institutional Scorecard attempts to shed light on these questions by providing coverage of institutional account performance alongside mutual fund data from the flagship SPIVA US Scorecard. Figure 2 shows the difference in 10-year underperformance rates between institutional accounts and mutual funds on both a net and gross basis of fees.

The chart illustrates some notable observations. First, long-term net fee performance for institutional accounts outperformed mutual funds in 20 of 21 reported equity segments, with international small-cap funds being a notable outlier. Second, gross relative fee performance for institutional accounts was better for 17 out of 21 equity categories. Third, with the exception of a few categories, the differences between the underperformance rates of mutual funds and institutional accounts were generally negligible, with major underperformance for institutional accounts in all categories, both on a gross and net of fees basis.

While long-term results may slightly favor institutional accounts over mutual funds, short-term results may vary. In our most closely watched category, All Large-Cap Funds, 66% of institutional accounts underperformed the S&P 500® in 2023, weaker than the 60% rate we observed for active large-cap mutual funds . Consistent 10-year majority underperformance rates across categories highlight the challenges of outperformance and show that institutional investors are no exception to the rule.

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