Stick With Passive Mid-, Small-Cap ETFs Over Active Funds

There is a slew of data points suggesting that active management has some, to put it delicately, shortcomings. Those issues are particularly acute when drifting away from large caps to mid and small caps.

“The March 2016 persistence scorecard, published last week, showed that just 19 percent of small-cap funds and 24 percent of mid-cap funds that were top-half performers in the 12-months ended March 2014 were able to maintain top-half performance in two consecutive 12-month periods. Performance consistency was strongest for large-cap funds, but still only 30 percent maintained a top-half ranking,” said S&P Capital IQ in a note out Monday.

The Appeal Of Smaller Caps

Other data points regarding actively managed mid- and small-cap funds remind investors of the old saying that past performance is not a guarantee of future returns, meaning some high-flying active mid- and small-cap funds do not always prove durable.

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“Previously top performing mutual funds can — and regularly are — shut down. S&P Dow Jones Indices looked at the 868 domestic equity mutual funds in the top half of their respective market-cap category and found that 34 percent of them were either merged or liquidated five years later,” noted S&P Capital IQ.

Making matters worse are the high fees associated with actively managed small-cap funds, which by some estimates are as high as 1.37 percent per year. On the other hand, investors can own the iShares S&P SmallCap 600 Index (ETF) IJR for just 0.12 percent per year, or $12 on a $10,000 investment.

It Can Still Be Costly

Active mid-cap funds are not exactly cheap when it comes to fees, either, with the average being 1.35 percent per year. That certainly makes the 0.08 percent annual fee on the Vanguard Mid-Cap ETF VO seem all the more attractive.

For just 0.38 percent per year, or nearly 100 basis points less than the average actively managed mid-cap fund, investors looking for exposure to mid caps can tap the WisdomTree MidCap Dividend Fund (ETF) DON.

Not only does DON sport a higher dividend yield than traditional mid-cap indexes, such as the S&P MidCap 400, and 10-year Treasurys, but the WisdomTree ETF has a lengthy history of topping its actively managed rivals. Over the past decade, DON has topped 94 percent of rival funds in the Morningstar Mid-Cap Value category.

S&P Capital IQ has a Market-Weight rating on IJR and an Overweight rating on VO.

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