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Mutual funds: ​Are you paying for underperformance?

Many investors think that paying more for active management, such as investing in the hottest mutual fund, will result in oversize returns. However, active managers are largely failing to keep up with the market.

About 86 percent of all U.S. large-cap funds failed to match the S&P 500 last year, according to the latest study based on S&P Dow Jones Indices' SPIVA U.S. Scorecard. But 2014 was far from a fluke. The report found that 10-year returns for U.S. active managers were hardly better, with 82 percent of large-cap managers failing to match the index.

The findings will likely add ammunition to proponents of low-cost index investing, such as Vanguard, who argue that passive investing -- or putting money into funds that mirror an index -- is a smarter way to invest. Advocates of passive investing also point to the difference in costs, given that active funds charge about 74 basis points, compared with about 43 basis points for passive exchange-traded funds, or ETFs.

That may explain why assets in ETFs have surged to about $2 trillion, or more than double the roughly $1 trillion in these vehicles in 2010. Of course, S&P Dow Jones Indices has a horse in the race, given that it licenses its indices to products such as ETFs.

"It is commonly believed that active management works best in inefficient environments, such as small-cap or emerging markets," the report noted. "This argument is disputed by the findings of this SPIVA Scorecard. The majority of small-cap active managers have been consistently underperforming the benchmark over the full 10-year period as well as each rolling 5-year period, with data starting in 2002."

The study found that the majority of both small- and mid-cap fund mangers underperformed their benchmarks over time, as well.

"There is nothing novel about the index versus active debate. It has been a contentious subject for decades, and there are few strong believers on both sides, with the vast majority of investors falling somewhere in between," the report noted.

Still, it may give pause to some investors who favor active management. Large-cap growth managers had an especially tough year in 2014, with 96 percent failing to match or exceed the S&P 500 Growth index. Small-cap value funds also had a poor showing, with 94 percent failing to beat the S&P SmallCap 600 Value index last year.

Because most active managers end up lagging the market, that puts the onus on investors to pick winning horses. But the given the long- and short-term underperformance by most managers, the odds are against investors being able to single out those top fund managers, as well as to pick winners year after year.

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