Morningstar Magazine - August/September 2018 - 35
EXHIBIT 5
EXHIBIT 6
Fee Effect Taking the gross excess returns in Exhibit 3 and
accounting for fees show how much fees weigh on funds'
success. Net excess returns of category medians are negative for
all 25 categories.
Even Best Funds Don't Outperform After Fees With a few
exceptions, the median net excess return of the funds in the best
quintile comes very close to zero.
First quartile
Third quartile
-10
-8
-6
-4
3-Year Net Excess Return Medians
Minimum
Maximum
-2
0
Median
Vs. ETF
2
4
Vs. Benchmark
-2
-1
0
Net Excess Return Median of 20th Percentile
1
2
Data from 12/2012-10/2017.
periods. EAA fund global emerging-markets
corporate bond tied for first place at
0.76% annualized excess return, but with a much
wider range of outcomes for the average
fund in this small category. If an investor selected
a fund at random in these two categories, the
baseline expectation (median) would be the
same, but the probability of hitting anywhere near
that point estimate would be vastly different.
These results suggest that we should not expect
to beat benchmarks or even passive vehicles
on an after-fee basis just by betting on the median
fund. It is, therefore, instructive to see how much
better odds are available to investors who are
successfully able to select the better performers
in a category.
We show in EXHIB IT 4 how funds at the cutoff
of the top quintile of their categories have
performed against their category's index
in three-year rolling periods, on a gross and net
of fees basis. The chart shows the kind
of excess returns investors could have achieved
if they had the foresight to select funds
that landed at the borderline of the best quintile
of their categories. In most categories, funds in
the highest quintile were able to outperform
the category index over time. The most lucrative
areas for fund-pickers are categories where the
best funds tend to beat the benchmark by
a large margin and with a high hit rate. Examples
include EAA fund EUR corporate bond, U.S.
fund corporate bond, and U.S. fund intermediateterm bond.
Using the headline results in EXHIBIT 3 , investors
can form baseline expectations of before-fee
returns and then consider what level of fees might
global.morningstar.com/Morningstarmagazine
35
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