Cheaper Is Not Better: On the ‘Superior’ Performance of High-Fee Mutual Funds

In contrast with theoretical predictions, high-fee active equity funds generate worse net-of-expenses performance. We show that this fee-performance puzzle is driven by the preference of high-fee funds for stocks with low operating profitability and high investment rates, characteristics associated with low expected returns. After controlling for exposures to profitability and investment factors, we find high-fee funds significantly outperform low-fee funds before expenses and achieve similarly poor net-of-fees performance. In resolving the fee-performance puzzle, our findings provide support to the theoretical prediction that net alphas are unrelated to fees and challenge the common advice to prefer low-fee funds over high-fee counterparts. (JEL G23, G11, J24)Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.