Derivative use,fund flows and investment manager performance

Prior literature which examines the use of derivatives by investment managers does not discern between different types of derivative trading strategies. This study is the first to examine and gather data on a particular type of derivative trading strategy undertaken by investment managers. We examine the extent to which equity fund managers use index futures to manage fund flows and the effect this has on their alpha and market timing measures of performance. Our results show that funds that do not use derivatives exhibit lower returns and negative market timing skills when they experience fund flow. The performance of funds that use derivatives, however, is independent of investor’s liquidity demands. In fact, the unconditional performance of the average user fund is statistically equivalent to the performance of the average non-user fund conditional on zero fund flow. Our results provide evidence that derivatives can be beneficial for mutual fund holders under certain conditions.     

Tax-Efficient Asset Management: Evidence from Equity Mutual Funds

We investigate the relation between tax burdens and mutual fund performance from both a theoretical and an empirical perspective. The theoretical model introduces heterogeneous tax clienteles in an environment with decreasing returns to scale and shows that the equilibrium performance of mutual funds depends on the size of the tax clienteles. Our empirical results show that the performance of U.S. equity mutual funds is related to their tax burdens. We find that tax-efficient funds exhibit not only superior after-tax performance, but also superior before-tax performance due to lower trading costs, favorable style exposures, and better selectivity.     

The economic gain of being small in the mutual fund industry: U.S. and international evidence

Motivated by the ongoing debate on the interaction between fund size and fund performance, we investigate the effect of asset growth on fund performance. We explicitly measure the economic gain (loss) of being a small (large) fund by comparing the average performance of a large fund vis à vis its average performance when it was small. Our results reveal that for the U.S. actively managed equity funds, the risk-adjusted return differential amounts to 7.08% per year in favor of small funds. Moreover, we fail to identify any performance loss for a fund relative to its history unless it belongs in the top 70% of fund size. However, the documented implicit performance handicap of U.S. large equity funds is not met in funds investing outside the U.S. Our findings carry important implications for the mutual fund industry and for the fund selection process.     

Can Mutual Fund “Stars” Really Pick Stocks? New Evidence from a Bootstrap Analysis

We apply a new bootstrap statistical technique to examine the performance of the U.S. open‐end, domestic equity mutual fund industry over the 1975 to 2002 period. A bootstrap approach is necessary because the cross section of mutual fund alphas has a complex nonnormal distribution due to heterogeneous risk‐taking by funds as well as nonnormalities in individual fund alpha distributions. Our bootstrap approach uncovers findings that differ from many past studies. Specifically, we find that a sizable minority of managers pick stocks well enough to more than cover their costs. Moreover, the superior alphas of these managers persist.     

Luck versus Skill in the Cross‐Section of Mutual Fund Returns

The aggregate portfolio of actively managed U.S. equity mutual funds is close to the market portfolio, but the high costs of active management show up intact as lower returns to investors. Bootstrap simulations suggest that few funds produce benchmark‐adjusted expected returns sufficient to cover their costs. If we add back the costs in fund expense ratios, there is evidence of inferior and superior performance (nonzero true α) in the extreme tails of the cross‐section of mutual fund α estimates.     

The impact of the Arab Spring and the Ebola outbreak on African equity mutual fund investor decisions

Financial development and stock markets have been widely considered to be key factors in economic growth. Among institutional investors, mutual funds play a key role in providing financial resources to stock markets, particularly in developing countries. Different from other investments, mutual fund flows could be affected by retail investors’ behavior and their overreaction to specific events. We considered 78 equity mutual funds that are geographically specialized in African countries and observed monthly flows and performance for the period of 2006–2015. We find that two major events, Ebola and the Arab Spring, significantly affected the fund flows, controlling for fund performance, expenses and market returns. Retail investors over-reacted to these major events, withdrawing their savings from the African mutual funds. This result is particularly strong when connected to the media coverage of these events: the higher the number of articles about Arab Spring and Ebola, the higher the withdrawals. These irrational investors’ behavior damaged the funds’ managers market timing ability, and reduced the equity capital injection into African stock markets. Our results have several implications for both holders of frontier market mutual funds and the overall asset management industry.     

How Are Derivatives Used? Evidence from the Mutual Fund Industry

We investigate investment managers' use of derivatives by comparing return distributions for equity mutual funds that use and do not use derivatives. In contrast to public perception, derivative users have risk exposure and return performance that are similar to nonusers. We also analyze changes in fund risk in response to prior fund performance. Changes in risk are substantially less severe for funds using derivatives, consistent with the explanation that managers use derivatives to reduce the impact of performance on risk. We provide new evidence regarding the implications of cash flows and managerial gaming for the relation between performance and risk.     

Gender,style diversity,and their effect on fund performance

This paper examines the performance of 358 European diversified equity mutual funds controlling for gender diversity. Fund performance is evaluated against funds’ designated market indices and representative style portfolios. Consistently with previous studies, proper statistical tests point to the absence of significant differences in performance and risk between female and male managed funds. However, perverse market timing manifests itself mainly in female managed funds and in the left tail of the returns distribution. Interestingly, at fund level there is evidence of significant overperformance that survives even after accounting for funds’ exposure to known risk factors. Employing a quantile regression approach reveals that fund performance is highly dependent on the selection of the specific quantile of the returns distribution; also, style consistency for male and female managers manifests itself across different quantiles. These results have important implications for fund management companies and for retail investors’ asset allocation strategies.     

Fund ESG performance and downside risk: Evidence from China

Whether responsible investing reduces portfolio risk remains open to discussion. We study the relationship between ESG performance and downside risk at fund level in the Chinese equity mutual fund market. We find that fund ESG performance is positively associated with fund downside risk during the period between July 2018 and March 2021, and that the positive relationship weakens during the COVID-19 pandemic. We propose three channels through which fund ESG performance could affect fund downside risk: (i) the firm channel in which the risk-mitigation effect of portfolio firms’ good ESG practices could be manifested at fund level, (ii) the diversification channel in which the portfolio concentration of high ESG-rated funds could amplify fund downside risk, and (iii) the flow channel in which funds’ better ESG performance may attract greater investor flows that could reduce fund downside risk. We show evidence that the observed time-varying relationship between fund ESG performance and downside risk is driven by the relative force of the three channels.     

Returns from Investing in Equity Mutual Funds 1971 to 1991

Several recent studies suggest that equity mutual fund managers achieve superior returns and that considerable persistence in performance exists. This study utilizes a unique data set including returns from all equity mutual funds existing each year. These data enable us more precisely to examine performance and the extent of survivorship bias. In the aggregate, funds have underperformed benchmark portfolios both after management expenses and even gross of expenses. Survivorship bias appears to be more important than other studies have estimated. Moreover, while considerable performance persistence existed during the 1970s, there was no consistency in fund returns during the 1980s.     

What determines fund performance persistence? International evidence

We study performance persistence across a global sample of equity mutual funds from 27 countries. In contrast to the existing U.S.‐based evidence, we find that net performance persistence is present in the majority of fund industries, suggesting that fund manager skill is commonplace rather than a rarity. Consistent with the intuition that more competition in the mutual fund industry makes remaining a winner fund less likely but keeping a loser fund at the bottom of the performance ranks more probable, we show that competitiveness explains the cross‐sectional variation in performance persistence.     

Is Index Performance Achievable? An Analysis of Australian Equity Index Funds

This article examines the performance of index equity funds in Australia. Despite the significant growth in index funds since 1976, when the first index mutual fund was launched in the U.S., research on their performance is sparse in the U.S. and non-existent in Australia. This study documents the existence of significant tracking error for Australian index funds. For example, the magnitude of the difference between index fund returns and index returns averages between 7.4 and 22.3 basis points per month across index funds operating for more than five years. However, there is little evidence of bias in tracking error implying that these funds neither systematically outperform nor underperform their benchmark on a before cost basis. Further analysis provides evidence that the magnitude of tracking error is related to fund cash flows, market volatility, transaction costs and index replication strategies used by the manager.     

On luck versus skill when performance benchmarks are style-consistent

We firmly believe that style-appropriate, investible benchmarks not only provide a more parsimonious way of describing manager performance, but also better aligns performance evaluation with the real world performance targets of fund managers’. It is against such benchmarks that managers should be judged. With this principle foremost in our approach, we use style-consistent benchmarks to determine whether any observed alpha produced by a sample of U.S. equity funds is due to skill or to luck. We find that different segments of the market, ranging from large-cap growth to small-cap value, exhibit different levels of skill and luck. Our results also show that the use of standard multi-factor models underestimates managerial ability and overstates the proportion of funds whose abnormal performance can be attributed to chance rather than to skill, when compared against the use of style-consistent practitioner benchmarks. We also find that a single factor performance evaluation model that uses Russell Style indices consistent with the style orientation of a fund and market practice provides a parsimonious way of accounting for fund performance. Finally, our findings should be of particular relevance in mutual fund markets where the risk factors commonly used in the academic literature to evaluate manager performance – SMB, B/M, MOM and others – are not readily available.     

Why mutual funds “underperform”

I propose a parsimonious model that reproduces the negative risk-adjusted performance of actively managed equity mutual funds. In the model, a fund manager can generate state-dependent active returns at a disutility. Negative expected performance and mutual fund investing simultaneously arise in equilibrium because the active return the fund manager generates covaries positively with a component of the pricing kernel that the performance measure omits, consistent with recent empirical evidence. Using data on U.S. funds, I also document new empirical evidence consistent with the model's cross-sectional implications.     

AN EMPIRICAL ANALYSIS OF MUTUAL FUND EXPENSES

Mutual fund investors are subjected to many fees and expenses related to both the management of the fund assets and the sale and distribution of the fund's shares. In recent years these expenses have increased as a percentage of assets. The preoccupation of mutual fund investors with using performance evaluation as a selection criterion is misguided because of the volatility of investment returns. Whether the fund's performance is due to superior management or just good luck is difficult to determine. On the other hand, mutual fund expenses are stable. As such, the mutual fund investor should pursue a policy of choosing funds with low expenses. In this paper we conduct an empirical analysis of these expenses. The results of our analysis of equity funds suggest that expense-conscious investors should look at the fund size, age, turnover ratio, cash ratio, and existence of a 12b-1 fee as key determinants of expenses. Our analysis of bond funds suggests that the key factors are the fund's sales charge, weighted average maturity, size, and existence of a 12b-1 fee.     

The performance of US equity mutual funds

The paper examines the performance of US no-load equity mutual funds. Fund performance is derived using stochastic frontier analysis for a flexible functional form. This analysis allows us to derive parametric estimates of efficiency scores for each fund in our sample for the first time in the literature. Our results indicate that US no-load equity funds display varying levels of efficiency over time but also depending on size and on investment style. Robustness analysis reaffirm the efficiency scores remain consistent across different selections of inputs and outputs as well as the underlying distribution of the return. Having estimated each fund’s efficiency in the sample we unveil their underlying dynamics, also with respect to risk and operational characteristics such as flows, assets, and Morningstar star ratings. Panel-VAR estimations reveal that the response of funds’ efficiency to a shock in risk is positive and substantial. Some evidence of reverse causality is also observed. Finally, we extend our analysis to investigate the relationship between funds performance and key covariates across subgroups defined by size.     

Is Concentration a Good Idea? Evidence from Active Fund Management

In this paper, we examine whether mutual fund managers in Taiwan produce superior performance through concentrated investment strategy, and find that mutual funds with higher degree of concentration have higher investment performance and lower risk during the period 2001–2009. Moreover, when the degree of industry concentration of fund holdings is higher, there is less impact on stock market performance. However, the premium of the market portfolio has more impact on the performance of funds when there is lower degree of industry concentration. We also find that the stock-picking and market-timing abilities of mutual fund managers result in funds with high degree of industry concentration having more returns and lower risks than the funds with low degree of industry concentration.     

Investment restrictions and fund performance

We examine the effect of investment restrictions on mutual fund performance. Utilizing a unique panel of mutual fund contract changes, we explore several ways these changes affect a fund, including: performance, funding risk, and managerial contracting. We find that the general shift towards fewer restrictions over the period 1996–2011 has provided little benefit to mutual funds. Specifically, neither performance nor flow increased and we observe no changes in risk on average. We do find, however, an increased likelihood of management turnover when restrictions are removed. We conclude that contract restrictions do not explain the general underperformance of mutual funds, and that these investment restrictions are not binding.     

Good Stewards, Cheap Talkers, or Family Men? The Impact of Mutual Fund Closures on Fund Managers, Flows, Fees, and Performance

We examine a sample of 125 equity mutual funds that closed tonew investment between 1993 and 2004. We find that funds closefollowing a period of superior performance and abnormal fundinflows. Fund managers raise their fees when they close to compensatemanagers for losses in income due to the restrictions in sizeimposed by the fund closure decision. Managers reopen when fundsize declines. However, they do not earn superior returns afterreopening, suggesting that the fund closure decision does notprovide information about superior fund managers. (JEL G14,G23)     

New Zealand mutual funds: measuring performance and persistence in performance

The present study investigates the performance of New Zealand mutual funds using a survivorship‐bias controlled sample of 143 funds for the period of 1990–2003. Our overall results suggest that New Zealand mutual funds have not been able to provide out‐performance. Alphas for equity funds, both domestic and international, are insignificantly different from zero, whereas balanced funds underperform significantly. There is no evidence of timing abilities by the fund managers. In the short term, significant evidence of return persistence for all funds is observed. This persistence, however, is driven by ‘icy hands’ rather than ‘hot hands’. Finally, we find the risk‐adjusted performance for equity funds to be positively related to fund size and expense ratio and negatively related to load charges.