Your Fund Could Prosper Without a Manager

Low fees and simplicity are common selling points for index funds. But they also outperform many mutual funds and hedge funds after taxes and fees are deducted, a new study says.

Mark Kritzman, chief executive officer of Windham Capital Management, calculated the average returns of three imaginary funds over a hypothetical 20-year period. Including fees and estimated taxes, index funds returned 8.5% a year on average, compared with 8% for actively managed mutual funds and 7.7% for hedge funds.

Financial experts continue to debate over which investing method yields the biggest returns long-term. Funds that are actively managed rely on stock picking and asset allocation strategies to maximize returns. Index funds, on the other hand, are designed to track a market index with the help of computer models.

When fees and taxes are excluded, the hypothetical hedge fund led the group with an annualized return of 19%. That compares with 14% for the theoretical mutual fund and 10% for the stock index fund, according to the study, published last month in the newsletter Economics & Portfolio Strategy.

The big picture: The main upside to actively managed funds is their potential to generate better returns than the broad market. An experienced manager with the right resources can separate the best stocks from those with weak prospects. But they sometimes make poor decisions, pursue unsound strategies or shift their investing style unexpectedly.

Index funds offer a straightforward and consistent investing approach, though they're designed to perform only as well as the indexes they track. That means that an actively managed fund that beats its benchmark index will also top the funds that follow that index.