MT422 Unit 7 Fund Comparison Report Example

The Best Ten-Year Return Ends Last: An MT422 Unit 7 Fund Comparison Report on Three Composite Vehicles

[Student Name]

Purdue University Global

MT422: Portfolio Management

Unit 7 Fund Comparison Report

[Instructor Name]

[Date]

All three funds, their fees, turnover, tax cost ratios and trailing returns are composite and labeled as such; the projection holds an assumed 8.0 percent gross return constant, and the sources cited are real.

The Holder and the Question

The holder is a composite 41-year-old who plans to invest $60,000 in a taxable brokerage account and leave it for twenty years. The money is already set aside for large U.S. stocks; the question is which vehicle to hold that exposure in. Because the account is taxable, the funds' tax efficiency matters as much as their fees.

The Three Vehicles

The active fund is an open-end mutual fund run by a manager who picks stocks within the large-company market. It charges an expense ratio of 0.82 percent, turns over 74 percent of its portfolio a year and has a tax cost ratio of 1.10 percent, meaning that taxes on its distributions have reduced its annual return by about that much for a holder in a typical bracket. Its trailing ten-year return is 10.9 percent a year.

The index fund is an open-end mutual fund that tracks a large-company index. It charges 0.05 percent, turns over 4 percent a year and has a tax cost ratio of 0.40 percent. Its trailing ten-year return is 10.4 percent.

The exchange-traded fund tracks the same index and trades on an exchange during the day. It charges 0.03 percent, turns over 3 percent and has a tax cost ratio of 0.25 percent. Its trailing ten-year return is also 10.4 percent.

Why the Trailing Return Misleads

On trailing return alone, the active fund wins by half a point a year. But that return is after fees and before taxes. Subtracting each fund's tax cost ratio gives an after-tax trailing return of 9.8 percent for the active fund, 10.0 percent for the index fund and 10.15 percent for the ETF. The order reverses before any projection is made.

A trailing return also describes one manager's past ten years, not the next twenty. Carhart (1997) found little persistence in mutual fund returns beyond what common factors and costs explain: funds with high past returns did not reliably keep outperforming, while funds with high expenses and turnover reliably underperformed. Costs are the one input that carries forward with some certainty.

Costs in Dollars

Expense ratios under one percent look small until they are expressed in dollars. On $60,000, the first year's fees are $492 for the active fund, $30 for the index fund and $18 for the ETF. Over twenty years, as the balance grows, the active fund's fees add up to about $18,300, against about $1,300 for the index fund. Federal guidance to investors makes the same point: small differences in ongoing fees compound into large differences in ending value over long periods (U.S. Securities and Exchange Commission, 2014).

Turnover

The active fund's 74 percent turnover means it replaces about three quarters of its holdings each year. Turnover costs money in two ways the expense ratio does not show. Trading costs, including commissions, bid-ask spreads and the price impact of large orders, come out of the fund's assets and lower its return directly. Sales of appreciated holdings also produce capital gains that the fund must distribute to shareholders, who owe tax on them in a taxable account even if they reinvest. The index fund and ETF, at 3 to 4 percent turnover, avoid most of both.

Why the ETF Is More Tax-Efficient

The ETF's lower tax cost comes from how its shares are created and redeemed. When large investors redeem ETF shares, the fund usually hands them a basket of the underlying stocks rather than selling stocks for cash. These in-kind redemptions let the fund pass out its lowest-cost shares without realizing gains, so fewer capital gains build up to be distributed. An index mutual fund that must sell stocks to meet cash redemptions cannot do this as easily, which is why its tax cost is higher even with similar turnover (Investment Company Institute, 2025).

The ETF's edge over the index fund comes almost entirely from how shares leave the fund, not from what the fund holds.

The Twenty-Year Projection

The projection holds gross return at an assumed 8.0 percent for all three funds, since there is no reason to assume any of them will earn more before costs, and lets only costs differ. After fees and tax costs, the active fund compounds at 6.08 percent, the index fund at 7.55 percent and the ETF at 7.72 percent.

After twenty years, the $60,000 grows to $195,354 in the active fund, $257,252 in the index fund and $265,508 in the ETF. The active fund's holder ends about $62,000 behind the index fund and about $70,000 behind the ETF. If the active fund's trading costs, not in its expense ratio, take another 0.2 to 0.4 percent a year, its ending value falls further, to between about $181,000 and $188,000.

For the active fund to match the ETF over twenty years, it would need to beat the index by about 1.6 percentage points a year before costs, every year, which is far more than the half-point lead its past ten years show.

What the Holder Gives Up

Choosing the ETF means giving up the chance that the active manager turns out to be one of the few who beat the index by enough to cover costs. The holder should know that the trade is deliberate: a known saving of about $70,000 against an unknown and, on the evidence, unlikely gain. It also means accepting the index's full weighting in the largest companies, since the ETF cannot avoid any stock the index holds.

Limits

The tax cost ratios depend on the holder's bracket and on market conditions, and could be lower or higher in another period. The projection ignores the tax due when the holder eventually sells, which would apply to all three funds but most to the two with larger unrealized gains. All figures are composite and illustrative.

Recommendation

For this holder, a twenty-year investor in a taxable account, the ETF structure suits the goal best: lowest fees, lowest turnover and the most tax-efficient way to hold the same index. The index mutual fund is a close second, and the better choice if the holder prefers automatic investment plans, which some brokerages offer more easily for mutual funds. The active fund would need an expected advantage the past ten years do not support. The choice is between structures, and it rests on costs that are known in advance rather than returns that are not.

References

Carhart, M. M. (1997). On persistence in mutual fund performance. Journal of Finance, 52(1), 57-82. https://doi.org/10.1111/j.1540-6261.1997.tb03808.x

Investment Company Institute. (2025). 2025 investment company fact book (65th ed.). https://www.ici.org/fact-book

U.S. Securities and Exchange Commission. (2014). Investor bulletin: How fees and expenses affect your investment portfolio. https://www.sec.gov/investor/alerts/ib_mutualfundfees.pdf