Measuring the True Cost of Active Management by Mutual Funds, from Alex Castaldo
Article by Daily Spec's Professor Ross Miller,from Alex Castaldo, in latest issue of Journal of Investment Management.
This article describes a rigorous method for allocating fund expenses between active and passive management. It also enables one to compute the implicit cost of active management. Computing this "active expense ratio" requires only a fund's published expense ratio, its R-squared relative to a benchmark index, and the expense ratio for a competitive fund that tracks that index. This method is then applied to the Morningstar universe of large-cap mutual funds and active expense ratios are found to average more than 7%. The cost of active management for other classes of mutual funds is also found to be substantial.