Institutional investors (i.e. mutual funds) outperform the market before fees—at the expense of retail investors, who underperform after fees. This conclusion comes from several recent studies, as detailed in an article in Advisor Perspectives.
The studies found that institutional investors have enough skills in stock-picking to generate gross alpha. And since that outperformance is a zero-sum game, they must be exploiting another group – such as retail investors. Those findings are consistent with research on the performance of retail investors, which one study calls “dumb money,” continues the article.
The article quotes Warren Buffett, who famously said that if you cannot value businesses “far better than Mr. Market, you don’t belong in the game. As they say in poker, if you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.” In this case, the patsies are retail investors.
It’s also a loser’s game for actively managed funds, which underperform year after year. Other studies have found that while fund managers are skilled enough to exploit retail investors, but not skilled enough to overcome all of their costs—making fund investors the losers in the game of active investing, and fund sponsors the winners.