Is Your Actively Managed Mutual Fund Just an Index Fund in Disguise?

A recent article from The Motley Fool highlights a problem with actively managed mutual funds that many investors may not have considered – they may be paying exorbitant fees for active management in a mutual fund that has much more in common with a passive index.  As the article more eloquently states:

“Unbeknownst to many investors, lots of mutual funds are pulling a fast one, grabbing more money in annual fees than they really deserve.  The problem is closet-indexing, which happens when a fund has too much in common with the S&P 500 index of 500 of America’s biggest companies, or with some other index that serves as its benchmark.”

As we’ve pointed out many times in the past, passive indexes typically outperform actively managed mutual funds.  So, what’s the problem then if these mutual funds are simply hugging a benchmark index?  Fees.

Since the average expense ratio on actively managed mutual funds is well north of 1%, you may be paying premium prices for performance that you can get much cheaper with an ETF, such as the SPDR S&P 500 ETF, ticker SPY, with an expense ratio of .09%.

This appears to be more than just an isolated issue which makes you wonder if the active mutual fund managers are finally coming to their senses and concluding “if you can’t beat them, join them”.  The only problem is that they’re not telling you that and they wouldn’t mind if you paid them extra as well.  Hardly a great deal.  No wonder that investors continue to pull money out of mutual funds and put it to work in ETFs.