What’s the best indicator of a mutual fund’s future performance? Is it a high Morningstar star rating? Being a Lipper Leader in multiple categories? Or perhaps having a long-term proven track record of outperformance?
A recent study published by Morningstar and picked up in the Wall Street Journal shows that while the above mentioned factors may be important, there is one (often overlooked) factor that may be the best indicator: a low expense ratio.
I say overlooked, because it is overlooked by many mutual fund companies and providers. It is, however, not overlooked by advisors and brokers who screen funds out for high expenses. Typically, they screen out funds for high expenses because it would be hard to explain their advisory fees on top of an already high fee charged by the mutual fund company. Now, advisors can use this indicator to seek funds with the potential for outperformance.
We encourage many of the funds that we work with to evaluate their fees and expenses and lower them to levels they are comfortable with. By doing so, they make their funds available to more potential investors (by making more screens), and help boost their performance.
This is also a great way for new funds to get noticed sooner. While new funds may not be rated by Morningstar and others for three years, they can always compete with the established funds on fees.
Sometimes, this is tough to do because smaller funds have higher expense ratios due to higher operating costs. In addition, fund firms may have difficulty lowering fees because this will sacrifice short term profits. But if you believe in your fund and feel that it’s going to be around for a while attracting investor dollars, then lowering fund fees will pay off many times over.
What are your thoughts on fees? Please leave a comment below.
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