Many mutual funds will be sending you a very special gift in the coming weeks — their annual capital gains distributions.

Mutual fund investors get the pleasure of filling government coffers with more of their hard-earned wealth–yippee!

Capital gains pain has arrived for U.S. mutual fund investors, to the tune of up to 60% of net asset value, according to the article.

Meanwhile, back in ETF land, investors are hardly paying any taxes:

iShares Capital Gains - iShares - Google Chrome_2014-01-05_21-12-15

Let us all remember that Taxes are More Important than Alpha …you can also review this truism here

So let’s recap ETFs versus Mutual Funds:

  • Lower fees, on average
  • More transparency
  • More investor control
  • WAY better taxes

Why do mutual funds exist again? Oh, I forgot…mutual funds are WAY better for asset managers:

  • Stickier assets
  • Lower transparency
  • Less investor control
  • Cash drag
  • Ability to leverage current distribution channels
  • etc. etc. etc…

The big argument might be that mutual funds possess magical powers to generate alpha. The evidence that mutual funds add value isn’t convincing.

However, there is evidence that mutual funds LOVE the broker distribution channel…hawking product…ohhhh….yeaaaaahhh…
Mutual Fund Performance and the Incentive to Generate Alpha

To rationalize the well-known underperformance of the average actively managed mutual fund, we exploit the fact that retail funds in different market segments compete for different types of investors. Within the segment of funds marketed directly to retail investors, we show that flows chase risk-adjusted returns, and that funds respond by investing more in active management. Importantly, within this direct-sold segment, we find no evidence that actively managed funds underperform index funds. In contrast, we show that actively managed funds sold through brokers face a weaker incentive to generate alpha, and significantly underperform index funds.

Any predictions on when ETFs will overtake Mutual Funds? 5 years? 10 years? Never?

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