Investors in actively managed mutual funds the last five years have reason to wonder what they've been paying for: A new study from Standard & Poor's finds that 70% of large-cap fund managers who use the S&P 500 as a benchmark for comparison have failed to match the performance of the index over that time.

That's double bad news, given that the index was down 19% in the five years that ended Dec. 31. The failure of active management is replicated across almost all categories, not only U.S. stock funds but also bond funds and even emerging-markets funds. What's more, those numbers are similar to the previous five-year cycle.

From the close of Dec. 31, 2003 to Dec. 31, 2008, the S&P 500 ($SPX) dropped 18.8% -- but that was still enough to beat 71.9% of U.S. actively managed large cap funds, according to S&P Index Services.

"We consistently see that once you extend time horizons to five years, the majority of active managers are behind their benchmarks," said Srikant Dash, global head of research and design at S&P.

"We're not saying people should be 100% in indexes," said Dash. "Most people don't want to settle for average returns, they want top quartile returns. But it's important to understand the risks and to know your odds of beating the index."

Things were even worse for small-cap active managers, said Dash. The S&P SmallCap 600 (SML) outperformed 85.5% of small-cap funds. That index was down 0.6% over the five years to Dec. 31.

"There's a prevailing myth that small cap is more of an active managers' market because they can find the little nuggets, but there's a lot to be questioned," said Dash. "People need to rethink the belief that the small-cap market is inefficient and needs active management."

Even among emerging-markets funds, for many years the darlings of mutual fund investors, most lagged their comparable S&P index. The S&P/IFC Emerging Markets Index bested 89.8% of actively managed emerging-markets stock funds in the past five years.

Actively managed bond funds also struggled. Except for high-yield funds, at least 80% of bond funds lagged their comparable benchmarks across all categories, said Dash. Because of liquidity issues, bond benchmarks are not as easy to replicate by index funds.

More evidence

The numbers from S&P are supported by research from Morningstar Inc.

Morningstar found that across its nine U.S. stock styles the average mutual fund beat its respective S&P index in only two style categories, and outperformed Russell indexes and Morningstar indexes in just three style categories over the five years through March 31. In all but one case of average fund outperformance, the difference was less than one percentage point.

"Index investing has proved its worth as a simple, no-nonsense, cheap and tax-efficient way of investing," said Dan Culloton, associate director of fund analysis at Morningstar.

But Culloton said that despite the numbers investors shouldn't ignore active management.

"There are going to be managers that beat their benchmarks," he said. "It's just hard to identify those managers or the years they'll do it."

Morningstar did find that the average fund beat all but one of its category Russell and Morningstar indexes over 10 years. It also beat the S&P indexes in five of the nine categories.

But the problem for investors is that while the average fund performance was better than most indexes, overall outperformance was still low. S&P doesn't calculate 10-year comparisons, but while 71.9% of large-cap funds lagged the S&P 500 in the past five years, 53% of large-cap funds lagged the index in the previous five years.

Five steps to success

Culloton said that when it comes to picking the right, index-beating fund, investors can try to "stack the odds in their favor" by following five steps before choosing a fund, most importantly knowing their fees.

"Funds in the lower fifth of a category for fees will have a significant head start," for returns, he said.

A fund manager's experience -- Culloton said a track record of at least 10 years is needed to determine whether returns are due to skill or luck -- how closely a fund's portfolio sticks to its strategy, and stewardship of a fund are also important.

Stewardship takes into account how a fund is run in the interests of shareholders, said Culloton, and one good measure is how much money managers invest in their own funds.

The least important step is focus on a fund's performance. This should ideally consider long-term returns through different cycles.

"That's a lot of work," for many investors, said Culloton. "That's why index investing has so much appeal...you have the peace of mind that you'll at least get market returns minus the fund's price."