While index funds typically underperform their benchmarks because their performance is handicapped by their small expenses, the median net difference has usually been well under one percentage point over the last 10 years, according to a "Index Fund & ETF Performance, a Lipper research report. "Index funds are just slightly underperforming their benchmarks," according to the report.
The average total expense ratio for institutional actively managed mutual funds is 0.909%, while the average total expense ratio for institutional index funds and ETFs is 0.550%, the report says.
Actively managed funds show more disparity in performance compared to the benchmark, with the median difference ranging from -352 basis points to +156 basis points over the last 10 years. The net median difference in performance for index funds and ETFs ranged from 0.00 to -104 basis points, according to the Lipper report.
"When expenses are added back, in every year in the last 10 years, greater than 50% of index funds and ETFs outperformed their benchmarks, reaching as high as 74.5% in 2002," the report says. "Also, the median difference in gross performance is always zero or greater. This demonstrates that most index funds and ETFs would outperform benchmarks if they did not have expenses."
Says the report: "Expenses and the nature of the funds handicap the performance of index funds and ETFs-in no year did over 50% beat the benchmarks they track except when expenses are added back. However, index funds and ETFs are able to stay closer to the performance of their benchmarks because the performance is only handicapped slightly by their small expenses. It seems as though index funds and ETFs miss out on the years where actively managed funds grossly outperform their benchmarks but they also miss out on the years where actively managed funds grossly underperform their benchmarks as well."
The report adds: "From a ten-year annualized perspective, index funds and ETFs perform similarly to actively managed funds. Actively managed large-cap funds returned a median of 2.42% and index funds and ETFs returned a median of 2.87%."