September 22, 2019

We have completed an extensive research study of mutual fund costs and returns for the period 2000 – 2016. A technical paper with the results will be released to the public in the coming weeks. Here we post a pre-release draft of the paper, and highlight some key findings which we are now using to present updated and improved estimates of fund ownership costs.

Among our findings are revised factors for estimating fund internal trading costs from reported fund turnover. We were previously using trading cost factors derived in our 2002 study. We are now using the factors derived in the new study and based on the more recent time period. The new estimates of trading costs are lower than our earlier estimates, presumably due to technology-driven efficiency improvements in the financial markets. The revised factors are:

Type of Fund Factor
Large-Cap U.S. Stock Funds -0.41%
Small and Mid-Cap U.S. Stock Funds -0.53%
International Stock Funds -0.87%
Bond Funds 0%
Alternative Asset Funds 0%

We cannot directly measure an individual fund’s trading costs. But these factors do give a meaningful estimate of the net impact that trading has on the average fund’s pre-expense returns (i.e. the returns before deducting the management fees as measured by expense ratio). The basic interpretation of these factors is as follows, using U.S. Small and Mid-Cap funds and the -0.53% factor as an example — with every 100% of reported turnover the average fund’s annual pre-expense return decreases by 0.53% (53 basis points). This implies that if the pre-expense return of the average fund with 0% turnover matches the return of the closest unmanaged benchmark index, then the average fund with 100% turnover would lag the index by 0.53% annually, the average fund with 200% turnover would lag by 1.06% annually and the average fund with 50% turnover would lag by 0.265% annually, etc.

The study did not produce statistically significant estimates of trading costs as a function of turnover for Bond Funds or for Alternative Asset Funds (e.g. commodities, futures). Therefore, the website does not now consider trading costs in comparing funds of those categories. So we use a turnover cost of 0% for these fund categories.

The new cost estimate algorithm also does not include trading costs for Pure Index Funds (defined here), the performance of which are directly measured against the corresponding benchmark index.

The draft technical paper is here.

May our ongoing investments in mutual fund research continue to assist you in making prudent investment decisions, whether for your own portfolio or for clients whom you advise.

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