With Actively Managed Funds, Be Wary Of Expense Ratios

The S&P healthcare sector is the best year-to-date performer.

If stocks from that space are leading the pack, then it makes sense you'd see healthcare mutual funds also sporting nice gains for 2014. Still, remember to be wary of expense ratios.

One leading fund, for example, is the Fidelity Select Health Care Portfolio (FSPHX). The fund holds about 77% of its assets in U.S. stocks, 21% in overseas stocks, and the remainder in cash. Up 16% year-to-date, this is an actively managed fund, with top holdings that range from Actavis plc ACT, to McKesson Corporation MCK, to Shire PLC SHPG.

Fidelity Select Health Care has a large-cap tilt, although small caps are represented. For an actively managed fund, the expense ratio is also not bad, at 0.76%.

Now trading at record highs, buyers who want exposure to the large-cap, global healthcare space may want to wait for a pullback.

A Different Example

Another healthcare vehicle with slightly less of a large-cap tilt is the Prudential Jennison Health Sciences Fund (PHLAX). In comparison to its Fidelity-managed peer, the Prudential fund carries a significantly higher expense ratio, 1.18 percent.

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The return numbers illustrate why this matters.

Prudential's year-to-date return is 17.25 percent, a little higher than the Fidelity Select. However, because of the higher fees, this fund has to work harder to deliver returns to investors.

A Broader Take

Put simply, investors can't count on actively managed funds to trounce an index on a consistent basis, while offsetting potentially higher fees. Keep that in mind when evaluating actively managed funds.

The S&P healthcare sector has advanced by just over 15 percent in 2014. In comparison, the Vanguard Health Care Index Fund Admiral Shares (VHCIX) is more or less tracking this basket of stocks; it sports a year-to-date return of 15.90 percent, and an expense ratio of 0.14 percent.

That cost is right in line with the SPDR Health Care Sector ETF's (XLV) expense ratio of 0.16 percent.

Vanguard's stated objective with the fund, in fact, is to track performance of the MSCI U.S. Investable Market Index/Health Care 25/50, a commercial index that contains healthcare stocks of all shapes and sizes.

With almost exactly the same composition as the two aforementioned actively managed funds, it's just one case where a lower expense ratio can lead to better returns.

Disclosure: At the time of this writing, Kate Stalter had no position in the equities mentioned in this report.