Determining the True Value of Actively-managed Mutual Funds

index or actively managed fundsThis is Part 2 of a 2 Part series on Actively-managed Mutual Funds.  

As I discussed in my previous article, Protecting Investors from High Costs,” contrary to popular belief, actively-managed funds, on average, have actually tended to under-perform a broad market benchmark in bear as well as bull markets.

In comparing the value of index mutual funds to actively-managed mutual funds, the issue of cost is often dismissed with a statement to the effect that actively-managed funds are more expensive than index funds due to the benefits received from the active management. However, there are serious questions regarding the “benefits” of active management.

To that end, let’s discuss The Active Management Value Ratio™ (“AMVR”) a proprietary metric that allows investors to measure the cost efficiency of actively-managed mutual funds. The AMVR is calculated by comparing the incremental cost of an actively-managed mutual fund to the fund’s incremental benefit, a concept introduced by Charles D. Ellis. Using incremental cost and incremental returns provides a more accurate evaluation of the contribution of active management.

The AMVR often shows that investors do not receive commensurate value for the additional costs of active management. In fact, the AMVR often shows that the active management component of actively-managed funds often reduces an investor’s return.

The Active Management Value Ratio is not, and is not intended to be, the Holy Grail, an end-all for investors. It is, however, a simple, straightforward tool offered to investors and fiduciaries to help identify and avoid actively-managed mutual fund fees that are shown to be unjustified in terms of cost-benefit efficiency, fees that unnecessarily reduce investors’ returns and may expose fiduciaries to unwanted liability exposure.

To calculate an investment’s AMVR, we need the following information for both the actively-managed mutual fund under consideration and an appropriate index fund: the actively-managed fund’s five-year annualized returns for both funds, and the annual expense ratio for both funds.

As an example of the value of the AMVR metric, let’s compare a hypothetical actively-managed mutual fund and an appropriate benchmark index fund, using the following data:

• Fund’s Five-Year Annualized Return – 20%
• Fund’s Expense Ratio – 1.00%
• Index Fund’s Five-Year Annualized Return – 18%
• Index Fund’s Expense Ratio – 0.22%

To make the calculation process even easier, we’ll use a simple chart consisting of two columns and five rows. We’ll use the left column to calculate annual fees information and the right column to calculate five year annualized return information. In our example, you would complete the charts as follows:

Annual Fees

5 Year  Annualized Return

Active Fund



Index Fund



Incremental Amount



Active Fund



Incremental %




The AMVR expresses cost efficiency in terms of incremental cost as a percentage of incremental benefit. In this case, the AMVR for the actively-managed mutual fund would be 7.8 times (78/10), or 780 percent, greater than the incremental benefit, showing that the incremental cost of the actively-managed mutual far exceeds the incremental benefits of the actively-managed mutual fund.

Put another way, 78 percent of the actively-managed mutual fund’s fee, which is attributable to the incremental cost of the active management, is producing only 10 percent of the fund’s return.  This disparity would make it extremely hard to justify this investment as a prudent investment choice.

Implications for Investors

If you currently have a financial advisor, ask them to perform this type of analysis on the products they sold you and/or the investments in your portfolio. If your advisor sells actively-managed products, they are most likely going to be hesitant to disclose this information to you, as it may expose legitimate questions involving the true value of such products and possible legal liability regarding the quality of advice you received.

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