The alpha killer
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For every one percentage point increase in fund expenses, some 0.78% is wiped off of alpha, according to Vanguard research.
According to the research, a fund’s expense radio is a more powerful predictor of relative performance than other readily more observable characteristics. While this research was based on US equity mutual funds, it will be a worry to UK retail investors, who over the past decade have seen 94% of active funds raise their fees according to recent research from Lipper.
The notion that higher costs hurt performance is nothing new, but the degree of damage Vangurd has found is. Vanguard’s research was based on examining the outperformance of US equity mutual funds by expense-ratio quartiles over five, 10, 15 and 20 years to the end of December, 2010.
The second most powerful variable was portfolio turnover. For every one percentage point increase in turnover, Vanguard notes alpha declined by 0.22 percentage points. Again the passive management industry has long argued the negative impact of portfolio turnover and its associated costs on active fund performance, but the research takes this argument up a notch was some hard numbers to back it up.
The active management industry can hit back with the argument that when they get it right it will negate such a loss. The problem as always is selecting those managers who can get it right, and do this consistently.
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