Actively managed mutual funds have always had a tough time matching up with their index-fund rivals. Now, just as things were looking up for active funds, one study questions whether even those that manage to beat their benchmarks are worth the risk they take.

Risk-adjusted returns
At first glance, a recent study conducted by Morningstar appears to have some positive news for active funds. The study found that over the past three years, roughly half of all active funds succeeded in outperforming whichever Morningstar index most closely resembles their investment objective.

However, those figures only take into account absolute returns, without adjusting for the amount of risk that fund managers took in generating those returns. Once you consider the extra risk that some managers needed in order to boost performance, the study found that as few as 37% of funds had better risk-adjusted returns than their benchmark index.

Going beyond the average
The real question for fund investors, though, is how to find those funds that will manage to beat their benchmarks even on a risk-adjusted basis. The study points to outperformance among funds with more assets under management, as well as higher levels of cash.

As an example, the study pointed to one strong-performing fund, Tweedy Browne Value (TWEBX). A quick look shows the fund to appear to be a typical conservative value fund, with blue-chip holdings that include Johnson & Johnson (NYSE:JNJ), Wal-Mart Stores (NYSE:WMT), and Philip Morris International (NYSE:PM). Moreover, it performed relatively badly during the bull market, finishing consistently in the bottom 20% of its category from 2003 to 2006.

Yet the Tweedy Browne fund's ability to preserve investors' capital during the 2008 bear market not only showed the flip side of its low-risk approach but also vaulted it toward the top of its category both in 2008 and over the past three years. Its low risk rating makes its strong performance all the more remarkable.

Searching for better funds
You can find a number of other mutual funds that meet similar criteria. Here are three low-risk funds that have done well:

Fund

5-Year Average Annual Return

Risk Rating

Holdings Include ...

Forester Value (FVALX)

3.9%

Low

Microsoft (NASDAQ:MSFT), 3M

Vanguard Dividend Growth (VDIGX)

4.2%

Low

ADP, UPS (NYSE:UPS)

Schwab Dividend Equity Select (SWDSX)

1.9%

Low

JPMorgan Chase (NYSE:JPM), IBM (NYSE:IBM)

Source: Morningstar.

Sure, those returns don't look all that impressive. But bear in mind that the S&P 500 increased even less than that over the past five years, with an average return of just 1.25% -- and these funds earned their returns with less volatility than an S&P 500 index fund would have had.

Curtains for active funds?
Morningstar's study seems like another nail in the coffin for the idea that active management is worth paying for. After all, if it's more likely than not that a fund you pick will turn out to be a dud, then you might do much better betting the odds and going with an index fund.

On the other hand, the more general takeaway from the study is that funds that can distinguish themselves on a risk-adjusted basis are much more valuable than some investors give them credit for. During long bull markets, the value of low-risk funds sometimes seems to go away, as high-octane growth-oriented funds that don't shy away from risk earn the biggest rewards and leave their conservative counterparts in the dust. Once the market inevitably hits turbulence, though, everyone suddenly appreciates the value of a risk-averse mutual fund again.

So while you do need to pay close attention to risk when researching active funds, there's still a place in your portfolio for the highest-quality ones. Just remember that in assessing a fund's performance, you'll want to notice not just how much they jump in good times but also how much protection they provide during bad times. Those two things combined will tell you a lot about how that fund will perform in the future.

Just because a fund does well doesn't mean it's a good buy. Foolish fund expert Amanda Kish points to several top-performing funds that don't belong in your portfolio.

Fool contributor Dan Caplinger still has money in a handful of active funds, although he's a big indexer. He owns shares of Philip Morris International. 3M, Microsoft, and Wal-Mart Stores are Motley Fool Inside Value selections. ADP, Johnson & Johnson, and UPS are Income Investor selections. Philip Morris International is a Global Gains recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy stays active for you.