Many stock mutual funds are down for the year, and the reason why has to do in part with high expenses and use of derivatives. The average diversified equity mutual fund has declined 5.9 percent this year, compared with only a 1.4 percent decline in the S&P 500 stock index, and 92 percent of equity mutual funds have lost value this year. (See John Waggoner’s USA Today article entitled “It’s been a pitiful year for stock funds”).
Midcap and small cap stocks have declined more than large cap. Waggoner says the Russell 2000 small cap index has declined 8.4 percent this year.
The average large cap international fund has declined 15.5 percent in the midst of the European sovereign debt crisis.
On the other hand, the average U.S. Treasury bond fund has spiked up 14.7 percent as investors fled to safety. And funds that invest in TIPS (Treasury Inflation Protected Securities) increased by 11 percent. Inflation is only 3.4 percent, but in the current low-yield environment that erosion is significant.
One of the primary reasons for this underperformance is high fees. The average fund charges 1.3 percent in expenses. Meanwhile, the Vanguard 500 Index Fund (Investor Shares) charges 0.17 percent. The difference is that over 1 percent of expenses is taken off the top for no particularly good reason.
A second contributor to underperformance is most new mutual funds’ use of futures and options to amplify returns.