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Index Funds Exclusive Content

Bascis of Index Funds

Fund Characteristics

  • Performance Tracking : each is designed to track the performance of a particular benchmark index such as the S&P 500.
  • Highly Diversified : often hold 100’s of securities. For example, an S&P 500 index fund generally holds all 500 stocks in the S&P 500 index.
  • Low Fees : average of approximately 0.22% * annually.
  • Low Turnover ** : minimizing hidden costs and other benefits.

Some Trade Like a Stock

  • Total Liquidity : Exchange Traded Funds (ETFs), a type of index fund, trade intraday like a stock on an exchange and can be bought and sold anytime.

More…

  • Total Transparency : see every security in the fund daily (ETFs).

* Funds recommended by Patton. ** Turnover is the buying and selling of securities INSIDE the fund.

Delivering performance consistent to indexes

The goal of traditional index funds is to produce performance that is consistent to that of a given index. For example, an S&P 500 Index Fund, an index of large U.S. stocks, is expected to replicate the performance of the S&P 500 Index; a Russell 2000 Index Fund, an index of small U.S. stocks, is expected to replicate the performance of the Russell 2000 Index.

The accompanying graph shows the performance of the statistically calculated S&P 500 index compared to the performance of an S&P 500 index Fund. This shows how the index fund has done a great job of replicating the performance of the index.

Source: S&P 500 Index from https://spindices.com; S&P 500 Index Fund is ETF symbol SPY.

Index Funds Performance Analysis

5-Year Ending

The accompany table demonstrates that each index fund has proven to produce performance with each of its applicable indexes.

5-Year Returns
Fund Benchmark Fund Return Benchmark Return Fund vs Benchmark Annual Fee
Source: Each Fund is per the listed symbol; S&P and Dow benchmarks from https://spindices.com; MSCI indexes from www.msci.com; Russell indexes from S&P Compustat, Gold Spot Price from http://www.lbma.org.uk/precious-metal-prices, ICE indexes from https://www.theice.com.

The success of low cost index funds has put significant downward pressure on the expense ratios of the average mutual fund. Althrough the average fee has moved meaningfully low, these fees are still well above the fees in the average index fund used in a Patton Super-Diversified Portfolio.

Source: https://www.ici.org/

A rapidly growing industry

The first index fund was created in the 1970's but did not begin growing rapidly until their success was proven. Investors have been aggressively moving money into index funds for many years now which has generally come at the expense of more expensive actively managed funds.

Index funds have grown rapidly during the last couple of decades. Investors have been moving money out of actively managed funds and into index funds.

Source: https://www.ici.org/
Source: https://www.ici.org/

The poor performance of actively managed funds

Low cost index funds are a proven success while the performance of the average actively managed fund has been a failure. The primary reason for this failure is higher costs including both higher expense ratios and higher hidden costs. This failure of active funds has been the case across nearly every asset class.

Average U.S. Fund Performance (Equal-Weighted)

Year Ending

The accompanying table shows the performance of the average fund in a wide range of asset classes compared to the index benchmark for each asset class. This data shows that the performance failure of the average funds is persistent over time and wide spread throughout the industry.

Fund Category / Benchmark 1-Year 3-Year 5-Year 10-Year
Source: https://us.spindices.com

% of Funds UNDERPERFORMING Benchmark

10-Years ending

The odds of a fund producing a return lower than its benchmark index is very high across all asset classes. During shorter periods of time, such as a single year, a fund's performance relative to its benchmark is random but, over time, the odds become very much stacked against an investor in actively managed funds.

Source: https://us.spindices.com

Fund Category

Performance Comparison

The accompanying graph compares the performance of the average fund in the selected fund category to there applicable benchmark for multiple time periods. Generally the longer the period of time, the higher the odds the benchmark index performs better than the average fund.

Source: https://us.spindices.com

% of Funds UNDERPERFORMAING Benchmark

The probability that a fund underperforms its benchmark index in a single year is random. Certain market conditions, with the benefit of hindsight, can actually favor actively managed funds. Generally, the longer the time period, the greater the odds that the average fund will underperform its benchmark index. The accompanying graph shows the % of funds in the selected fund category that underperformed their benchmark year-by-year.

Source: https://us.spindices.com

Fund Closure Rate

Fund companies routinely close funds most often by merging them into another similar fund they manage or by simply liquidating the fund. Most often funds are closed because their performance is not keeping up with their benchmark. Large fund companies often have dozens of funds allowing them to close / merger poorer performing funds with better performing funds. This makes it look like they have more better performing funds. The accompanying graph shows how many funds have closed during various time periods.

Source: https://us.spindices.com

Style Change Rate

In addition to fund companies closing poorer performing funds (above), another common practive is to change the sytle of the fund or change its fund category. Fund companies generally do this because a fund, again, has not performed as well as its benchmark. They will change the fund category to one where this fund HAS performed better than that particular fund category benchmark making the fund's performance look more attractive. The accompanying graph shows the number of funds that have had a style change during various time periods.

Source: https://us.spindices.com

Comparing Fund Performance to Benchmarks

The following allows you to select from multiple large fund families to see the performance of all their funds compared to an applicable benchmark. As is expected, some funds will do better than their benchmark but, generally, most will not. Note that this data only includes the funds that are still in existence, not their closed funds, which will make for a biased view looking as if the fund family has better peformance than it has actually delivered.

Select Fund Family

Additional Details

Fund Family Symbol Category (Asset Class) Expense Ratio Turnover Assets No. of Holdings Inception Patton Recommended
Source: Steele Mutual Fund Expert Database
Source: Steele Mutual Fund Expert Database
Compounded Returns
Current Fund :
Patton Recommended Fund :
Difference %
Source: Steele Mutual Fund Expert Database

Compounded Returns

Compounded Returns
Fund Returns Patton Recommended Fund Returns Difference %
Source: Steele Mutual Fund Expert Database
Only shaded funds are included in the average

Additional Mutual Fund Facts

  • Lack of Performance Persistence – high past performance is NOT an indication of future high performance 1.
  • Questionable Value of Morningstar Ratings – a low Expense Ratio is a better predictor of performance than Star Ratings 2.
  • Asset Size Matters – smaller funds lack economies of scale. Larger funds must buy and sell larger quantities of securities resulting in higher hidden expenses.
  • Similar Issues for Other Investment Vehicles – separate accounts, pooled investments, collective trusts, and other similar vehicles face many of the same issues as mutual funds 3.

1 Source: “Short-Term Persistence in Mutual Fund Performance”, Nicolas P. B. Bollen at Vanderbilt University and Jeffreyy A. Busse at Emory University, published in “The Review of Financial Studies”. 2 Source: “How Expense Ratios and Star Ratings Predict Success”, Morningstar, Russel Kinnel, August 9, 2010. 3 There is less reliable data on most other investment vehicles as compared to mutual funds (regulations do not require the same reporting as mutual funds) but nothing exists suggesting these other vehicles produce meaningfully different results.

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