Mutual Fund Performance

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					 Mutual Fund Performance and
 Manager Style. J.L. Davis, FAJ,
  Jan/Feb 01, 19-27
Various studies examined the
evidence of persistence in mutual
fund performance.
General consensus is that a few fund
managers do tend to consistently
appear near the top of the return

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Strong evidence that some fund
managers consistently appear near
the bottom of the ranking.
The implication for investors: Small
likelihood of consistently earning
abnormal returns by seeking
individual fund managers.
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Objective of this Study: Examine the
relationship between equity fund
performance and manager style.
     1. Examine whether any
investment style reliably delivers
abnormal performance;
     2.Evidence of performance per-
sistence based on style.
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Data and Methodology:
US Mutual Fund Database from
Time period: 1965-1998.
Data is free of Survivorship bias.
     Explain the problem with
survivorship bias.

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Selection Criteria for funds to be
included in the data set:
     1. If a fund’s stated objective was
growth, growth and income,
maximum capital gains, small-cap
growth, or aggressive growth;
     2. Objective not listed but policy
statement indicated that they
primarily invested in common stocks.
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Sample consisted of 4,686 funds
covering 26,564 fund-years from
1962-98, i.e.,in 26,564 time the
fund was classified as an equity fund
and had at least one valid monthly
     The median equity weight for
the fund year: 93 percent.

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Style Identification:
     Fama-French three factor model
as presented below is used to infer
fund’s investment style.
Rit–Rft=ai+bi(Rm,t–Rf,t)+si SMBt+
Rit= the percentage return to fund i,
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Rft = the U.S. T-bill rate
Rmt = the return on the CRSP value
weighted index,
SMBt = small cap return - large cap
HMLt = value return – growth return.
et = the error term.

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Factor loading (sign of coefficients):
     1. Small company stocks:
positive si ;
     2. Large company stocks:
negative si ;
     3. Value factor: positive hi;
     4. Growth factor: negative hi ;
     5. Intercept () measures
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    performance relative to three
    factor model.

Funds were identified as small cap
or large cap on the basis of SMB
slopes and as value or growth on
the basis of HML slope.

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Portfolio Formation: Funds were
placed in style portfolios at the
beginning of each year from 1965.
Returns for the previous 36 months
were used to estimate performation
slopes on the HML and SMB factors.
Based on the slopes, funds were
allocated into portfolios, and returns
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were calculated for each month of
The process was repeated for each
Univariate SMB and HML sorts to
form decile portfolios and bivariate
sorts to form portfolios based on
intersection of the HML and SMB
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Funds were divided into thirds (low,
medium and high) on the basis of
SMB and HML rankings.
This 3x3 partition produced nine
portfolios - high SMB/Low HML
(small/growth) portfolio.

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Test of performance persistence
used bivariate sorts on HML and 
and SMB and . For example, (Low
HML/Low ) implies growth
emphasis and performed poorly
compared with the three-factor

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Tests of Abnormal Returns:
1. Davis, Fama and French - three
factor model (excess market
returns, the size and value-growth
factors) have explanatory power;
 2. If premiums associated with size
and value can be earned by passive
strategy by buying diversified
portfolios with desired level of risk,
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therefore, an active manager should
be able to outperform such passive
Results- Style Based Portfolio
     Table 1- Three Factor Results,
HML Sorts.
     Panel A – Sorted by HML slope
     Panel B – Regression Results
     R2 and t values indicate in favor
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of three factor model.
      - HML coefficient: growth
      + HML coefficient: value
Deciles 1-6: growth based on HML
Deciles 7-10: value based on HML
Deciles 1-4 : positive 
Deciles 5-10: negative 
Decile 10 : (=-.2) and significant,
i.e., underperformance                 17
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Summary: Value fund did not
performed better than growth fund.
Table 2 - Three Factor Results, SMB
    R2 close to 1.
     negative and insignificant.
    Three factor model is appropriate

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Table 3- Independent HML and SMB
sorts portfolios
Panel A:
Low- Low corresponds to large-
growth portfolio;
High-High corresponds to small-
value portfolio
 No style portfolio show reliable
abnormal profit,a tendency for value
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funds to under perform growth fund
is clear when SMB sensitivity is held
Conclusion from Tables 1-3: Value
funds performed poorly over the
past 30 year period.

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Table 4: Independent sorts on HML
and .
Panel A: Average for each portfolio
Panel B: Regression coefficients
Panel C: Regression results one year
after formation
Panel A: The spread in  value
between low and high  portfolio is
about 1 percentage point.
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Panel B: For high HML portfolio, all
three  values are negative, i.e,
value funds have not done well.
 Low HML/high  has a +.14 
value, i.e., some growth mangers
have been able to maintain good
performance over short period.
Advantage disappears in Panel C.

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Table 5: Independent sorts on SMB
and .
Panel A: The spread in  value
between low and high  portfolio is
about 150 bps.
Panel B: The spread falls to 25 bps.
Panel C: Spread is less than 10 bps.
Conclusion: Some evidence of
persistence, but dies quickly.
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1. No investment style generated
   abnormal returns over 1965-98.
2. Small evidence of persistence
   among best performing funds;
   more evidence of performance
   persistence among poor-
   performing funds;
3. Funds did not capture value
   premium.                         24

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