Lipper Average: 4 Caveats Investors Should Know

In financial magazines and fund advertisements, you’ll often see boasts about funds that “consistently beat their five-year Lipper averages.” This claim sounds impressive at first glance, suggesting superior performance. But digging deeper reveals nuances that every investor should understand before getting excited.

The **Lipper average**, also known as the Lipper Index, serves as a benchmark for measuring mutual fund and ETF performance within specific categories. Produced by Lipper, a Thomson Reuters subsidiary, these averages group similar funds by factors like sector, market capitalization, and investment style, enabling apples-to-apples comparisons.

What Exactly Is a Lipper Average?

Lipper averages aggregate the returns of actively managed funds within defined categories, such as large-cap growth, small-cap value, or equity income. Unlike broad market indices like the S&P 500, Lipper focuses exclusively on peer groups of active funds, excluding passive index trackers.

Each Lipper index typically comprises the 30 largest funds in a category, weighted by assets under management. This setup allows portfolio managers and investors to evaluate historical trends, strengths, and weaknesses against direct competitors rather than passive benchmarks. Publications like The Wall Street Journal and Barron’s regularly feature Lipper data, underscoring its industry prominence.

Lipper classifies funds using a qualitative analysis of their prospectuses, considering factors like sector concentration, credit quality, and maturity for fixed-income funds. This differs from competitors like Morningstar, which may rely more on portfolio holdings or surveys. For instance, Lipper’s bond fund categories include core, core plus, flexible, and general, based on average maturity rather than duration.

• Key Classification Factors: Market cap, investment style (growth/value), sector focus, geography, and for bonds: credit quality and maturity.
• Average Calculation: Simple or asset-weighted mean of surviving funds’ total returns (including dividends and capital gains).

How Do Lipper Averages Work in Practice?

Fund companies use Lipper averages in marketing to highlight outperformance. A fund beating its Lipper average over one, three, or five years gets touted as evidence of skilled management. However, this metric has built-in biases that inflate perceived success.

Consider the process: Lipper collects net asset value changes, dividends, and distributions from active funds, then computes category averages. Ratings like Lipper Leaders rank funds 1-5 (1 being best) based on consistent risk-adjusted returns, total return, and expense efficiency. A “5” rating places a fund in the top 20% of its peers.

Z-scores play a role in style analysis, measuring how a fund’s characteristics (e.g., dividend yield, P/E ratio) deviate from category norms, aiding precise peer grouping.

This table illustrates common categories, showing how Lipper tailors benchmarks to fund objectives.

The Major Caveats: Why Beating the Lipper Average Isn’t Always Impressive

While useful, Lipper averages come with significant limitations that savvy investors must consider.

1. Only Actively Managed Funds—no Index Comparison

Lipper excludes low-cost index funds, which track benchmarks like the S&P 500 with minimal fees (often under 0.1%). Active funds incur higher expenses—typically 0.5-1.5% annually—for research and trading. Even if an active fund beats its Lipper peer average, it often lags the relevant index after fees.

Studies show most active funds underperform indices over time, making Lipper victories less meaningful without broader context.

2. Survivorship Bias Inflates Averages

Lipper averages include only currently existing funds. Poor performers that closed or merged vanish from historical data, retroactively boosting past averages. A fund shining in 2008 might disappear, leaving the average higher than reality. This bias can make beating the average seem easier than it is.

3. Category Apples-to-Oranges Risk

Even within categories, funds vary. One might allocate to alternatives like commodities, outperforming pure peers but skewing comparisons. Lipper’s prospectus-based classification helps, but overlaps with Morningstar categories range from 30-90%, creating inconsistencies.

4. Past Performance Isn’t Predictive

Fund ads emphasize 5-year Lipper beats, but momentum doesn’t guarantee future results. Manager changes, market shifts, or style drift can erode edges.

• Real-World Impact: High fees often erase active outperformance. A fund returning 9% with 1% fees nets 8%; an index at 10% with 0.05% fees wins.

When Should You Care About Lipper Averages?

Lipper averages shine for active fund shoppers. If committed to active management, pick funds consistently above their peers over 3-5 years—ideally with low fees and strong risk-adjusted metrics like Sharpe ratio.

Combine with other tools: Compare to indices, check expense ratios (<0.75% ideal), review manager tenure, and assess downside protection. Lipper ratings factoring volatility and expenses provide a holistic view.

For most investors, however, low-cost index funds or ETFs outperform active options net of fees. Beating Lipper peers doesn’t beat the market.

Lipper vs. Other Benchmarks: A Quick Comparison

Frequently Asked Questions (FAQs)

What is a Lipper average used for?

A Lipper average benchmarks active mutual funds and ETFs against category peers, helping investors compare performance within similar investment styles.

Do Lipper averages include index funds?

No, they focus solely on actively managed funds, excluding low-fee passive index trackers.

Is beating the Lipper average impressive?

It indicates relative strength among actives but often fails to beat market indices after fees. Check broader context.

What causes survivorship bias in Lipper data?

Closed or merged poor performers are excluded from historical averages, artificially inflating them.

How do Lipper ratings work?

Ranked 1-5 (1 best) on total return, consistency, risk-adjusted returns, and expenses. Top 20% get “5” as Lipper Leaders.

Should I invest based on Lipper performance?

Use as one tool alongside fees, indices, and manager quality. Past results don’t predict future gains.

Final Thoughts for Investors

Lipper averages offer valuable peer insights but aren’t the holy grail. Question fund ads claiming consistent beats—many overlook biases and fees. Prioritize low-cost, diversified strategies for long-term success. Whether active or passive, understanding benchmarks like Lipper empowers better decisions.

This article is general information, not personal financial advice. Consider your own situation, or speak with a licensed adviser, before acting on it.