THE INVESTOR’S CHOICE BETWEEN ACTIVE AND INDEX FUNDS

Abstract

This study compares the performance of actively-managed mutual funds and index funds. For a large sample of US domestic equity share-class funds, we analyze the relation between portfolio turnover and fund risk-adjusted return. Using gross returns, results indicate that before (after) the onset of the recent financial crisis, low-turnover active funds reach higher (similar) results than those obtained by index funds, whilst high-turnover active funds have similar (worse) returns to index funds. The same evidence is found when net returns are considered, but index funds perform comparatively better due to their lower costs. From an investors’ perspective, investing in previous high-turnover funds could lead to lower overall risk-adjusted returns.