Are Actively Managed Mutual Funds Per Se Imprudent Choices for 401(k) Plans?

Abstract

Many corporations and financial institutions have recently faced lawsuits in which plaintiffs have alleged harm to 401(k) plan participants by the inclusion of high-fee actively managed mutual funds in plan offerings, instead of low-cost index funds. The goal of our study is to compare the performance of actively managed and passive index funds. Using a large dataset of more than 11,000 mutual funds, we find that, on average, actively managed funds do have higher fees than their index fund counterparts. However, a portfolio of active funds chosen based on certain key characteristics, such as low expense ratio, low turnover, high Sharpe ratio etc., have better net-of-fees returns than passive index funds in the categories of US equity, international equity, fixed income, and mixed assets. The findings in our study imply that inclusion of a higher-fee active fund in a 401(k) plan does not necessarily imply an inferior or imprudent choice. TOPICS: Retirement, mutual fund performance, performance measurement