Seasonality, Market Timing and Performance Amongst Benchmarks and Mutual Fund Evaluation

Abstract:  Mutual fund performance is normally measured by comparing results of active management with those obtained by one or several benchmarks that should represent the fund's investment. In this context, this paper examines the effect on mutual fund assessment if a relevant benchmark is omitted. This effect is analysed in three elements of active management: stock selection, market timing, and seasonality. The latter is defined as fund management at specific moments of time with the objective of achieving positive abnormal returns to improve performance. For a sample of Spanish mutual funds, we find that the omission of style benchmarks, particularly that corresponding to small-cap stocks, leads to greater evidence of negative market timing and positive seasonality at year beginning. However, the positive abnormal returns of the seasonality at year end, month end and especially at the beginning of July hold regardless of benchmark omission. The paper therefore also analyses the relation between performance and seasonality, finding that positive seasonality at year beginning and at July beginning improves performance; however, at other moments it implies a possible window dressing strategy in mutual fund management.     

De facto time-varying indices-based benchmarks for mutual fund returns

We question time-invariant indices as fund benchmarks and propose a regime-switching methodology to identify time-varying de facto benchmarks from a pool of market-based indices, with or without a risk-free asset. To ameliorate the benchmark mismatch issue, we highlight the importance of using time-varying indices-based benchmarks for fund performance evaluation. Our de facto benchmark captures fund styles better than other benchmark choices, substantially improves the identification of significant fund alphas, and provides better out-of-sample forecasts. We uncover several new findings in terms of fund performance evaluation using our de facto benchmarks.     

Performance evaluation and self-designated benchmark indexes in the mutual fund industry

Almost one-third of actively managed, diversified U.S. equity mutual funds specify a size and value/growth benchmark index in the fund prospectus that does not match the fund's actual style. Nevertheless, these “mismatched” benchmarks matter to fund investors. Performance relative to the specified benchmark is a significant determinant of a fund's subsequent cash inflows, even controlling for performance measures that better capture the fund's style. These incremental flows appear unlikely to be rational responses to abnormal returns. The evidence is consistent with the notion that mismatched self-designated benchmarks result from strategic fund behavior driven by the incentive to improve flows.     

Persistent performance in the mutual fund market: Tests with funds and investment advisers

Recent studies of mutual funds have concluded that there is some evidence of superior performance. We test for the existence of superior performance and its persistence with mutual funds and mutual fund investment advisers on a data set of monthly returns from 1979 to 1989 for 1,387 mutual funds grouped by 243 advisers. We find no evidence of superior performance or its persistence but we do find significant evidence of persistence of inferior performance. Consistent with previous studies our findings depend on the benchmark chosen, with multiple benchmarks producing a larger degree of inferior performance.     

Synthetic hedge funds

We provide evidence on the performance and the replication success of a broad sample of 72 synthetic hedge funds from January 2009 to December 2013. Thereby, we assign the term “synthetic hedge fund” to mutual funds and exchange-traded funds with hedge fund indices as their benchmarks. Replication success is measured through different perspectives from distributional characteristics to risk-adjusted performance. We find an overall significant underperformance of synthetic hedge funds compared to an appropriate benchmark index. Furthermore, mutual funds (associated with active portfolio management) can produce return characteristics closer to hedge fund benchmarks than exchange-traded funds (associated with passive management) can. From a single strategy perspective, we find a picture of heterogeneity. Regarding the market environment, we show larger return differences for unusual market conditions than for regular ones.     

Performance Chasing,Fund Flows and Fund Size in Real Estate Mutual Funds

Real estate mutual funds have grown dramatically in number, size, scope and assets under management over the last 15 years, but little assessment is evident. The present study addresses this limitation. Better prior period performance is associated with greater shares of fund inflows for a period. Returns, however, are negatively associated with increased fund flows and fund size. Investors chase past performance limiting fund managers’ ability to optimize investments. Under normal market conditions, but departing from typical mutual fund performance, real estate mutual fund returns generally exceed relevant benchmarks on a before expenses basis and match benchmark returns after expenses. The ability to meet and exceed benchmark returns, however, does not hold during the financial crisis period. Overall, more established funds are shown to have higher returns while fund turnover is not a determinant of returns.     

The attributes,behavior, and performance of U.S. mutual funds

This article examines the risk and return characteristics of U.S. mutual funds. We employ an equilibrium version of the Arbitrage Pricing Theory (APT) and a principal-components-based statistical technique to identify performance benchmarks. We also consider the Capital Asset Pricing Model (CAPM) as an alternative. We implement a procedure for overcoming the rotational indeterminacy of factor models. This procedure is a hybrid of statistical factor estimation and prespecification of factors. We estimate measures of timing ability for the CAPM and extend it to the APT. We find that this timing test is misspecified due to noninformation-based changes in mutual fund betas. We develop a modification of the timing measure that, under certain conditions, distinguishes true timing ability from noninformation-based beta changes.     

Selectivity and Market Timing Performance of Fidelity Sector Mutual Funds

In this paper, we test the selectivity and timing performance of the Fidelity sector mutual funds during the 1989–1998 time period. We use the S&P 500, the Dow Jones Industry Group Total Return Indexes, and the Dow Jones Subgroup Total Return Indexes as benchmarks. When we use the Dow Jones Industry benchmarks, our results indicate that many sector fund managers have positive selectivity but negative timing ability. We also find that the results are sensitive to our choice of benchmark and timing model.     

The Persistence of Mutual Fund Performance

This paper analyzes how mutual fund performance relates to past performance. These tests are based on a multiple portfolio benchmark that was formed on the basis of securities characteristics. We find evidence that differences in performance between funds persist over time and that this persistence is consistent with the ability of fund managers to earn abnormal returns.     

Mutual fund performance: Using bespoke benchmarks to disentangle mandates,constraints and skill

While no two mutual funds are alike in terms of their mandates and constraints, metrics used to evaluate fund performance relative to peers typically fail to account for these differences by relying on generic benchmark indices and rankings. We develop a methodology to construct a conditional multi-factor benchmark that explicitly incorporates the details of a given fund’s mandates and constraints. The results suggest that (i) mandates and constraints are economically important and affect funds differently, (ii) in general, the average mutual fund has a much improved track record when comparing themselves to a bespoke benchmark, and (iii) the rank ordering of fund bespoke performance relative peers is significantly different than the original rank ordering suggesting advisors and board of directors would make better decisions regarding compensation and performance assessment respectively, if they incorporate the impact of mandates and constraints.     

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.     

Benchmark Invariancy,Seasonality and APM-Free Portfolio Performance Measures

The Jobson-Korkie (1981) Z score and the positive period weighting (PPW) score of Grinblatt and Titman (1989) are applied to various benchmarks of market and mimicking portfolios to study the benchmark invariancy problem. Significantly different portfolio performance inferences are found for a sample of 146 equity mutual funds depending on the mean-variance efficiency of the portfolio benchmarks (mimicking portfolios versus market indices). Portfolio performance inferences are affected significantly by the number of factors, nonsynchronous trading adjustment, and the sizes of the firms used for factor extraction. The returns of the portfolio benchmarks exhibit significant monthly seasonalities, which, in turn, significantly influence mutual fund performance inferences.     

The performance of US bond mutual funds

We evaluate the performance of the US bond mutual fund industry using a comprehensive sample of bond funds over a long time period from January 1998 to February 2017. In this one study, we examine bond fund selectivity, market timing and performance persistence. We evaluate bond funds relative to their self-declared benchmarks and in terms of both gross-of-fee returns and net-of-fee returns. We document considerable abnormal performance among funds both to the fund (gross returns) and to the investor (net returns). Bond fund performance is found to be superior in the post financial crisis period. However, past strong performance cannot be relied upon to predict future performance. Finally, while some funds exhibit market timing ability; we find a predominance of negative market timing among US bond mutual funds.     

Short-term persistence in hybrid mutual fund performance: The role of style-shifting abilities

Our study analyzes the performance of hybrid mutual funds. Based on two extended Carhart models we determine total fund performance by comparing fund returns to investable fund-specific style benchmarks. Using daily returns and a quarterly measurement interval, we present an innovative return-based approach to decompose total performance into in-quarter abnormal performance and style-shifting performance. In addition, we split total style-shifting performance into active and passive components. In this context, we confirm possible benefits of these performance measures by analyzing several simulated investment strategies. Our empirical study covers 520 hybrid mutual funds from 10/1998 to 12/2009 and shows that hybrid mutual funds (i) do not outperform their benchmarks on average, (ii) partially show positive in-quarter abnormal performance and style-shifting abilities, and (iii) exhibit short-term persistence in in-quarter abnormal performance but not in style-shifting abilities.     

Benchmarking benchmarks: measuring characteristic selectivity using portfolio holdings data

This study proposes methodological adjustments to the widely adopted performance benchmarking methodology of Daniel et al. (1997 ) as a means of improving the precision of alpha measurement for active equity fund managers. We achieve this by considering the monthly updating of characteristic benchmarks and to ensure neutrality to the Standard & Poor's/Australian Stock Exchange 300 index. Applying this benchmark to a representative sample of active Australian equity funds and simulated passive portfolios that mimic fund manager‐style characteristics, we find statistically different and lower tracking error compared with using the standard characteristic benchmark methodology. We also find evidence that the modified benchmark statistically infers an alpha closer to zero compared with the standard benchmark methodology. Our findings suggest that improved specifications of characteristic benchmarks represent better methods in quantifying fund manager skill.     

Performance attribution of mutual funds in India: outperformance or mis‐representation?

We conduct a novel holdings‐based performance attribution, particularly suited to emerging markets, for equity‐oriented active mutual funds in India. Although, we find significantly positive alphas for an average fund, the stated benchmarks are grossly mis‐specified. A style‐adjusted benchmark could beat the stated benchmarks by greater margins than the funds themselves. While funds’ trading activity consistently adds value, cash drag and market timing usually diminish value. Although, the best‐performing funds exhibit superior security selection abilities, their outperformance does not persist. However, despite the lack of persistence winner funds continue to generate significantly higher alphas than loser funds for quite some time.     

The timing ability and global performance of Tunisian mutual fund managers: A multivariate GARCH approach

It is well-established in the financial literature that the global performance of mutual fund managers is the result of two skills: selectivity and market timing. This paper examines whether the multivariate Generalized Autoregressive Conditional Heteroskedasticity (GARCH) approach improves our perception of the global performance of fund managers compared with the unconditional approach and the conditional approach based on instruments. We find strong evidence that the multivariate GARCH method makes mutual fund performance looks better relative to the existent approaches, but this improvement in the global performance does not mean necessarily that mutual funds outperform traditional benchmarks. Indeed, mixed mutual funds yield neutral performance relative to benchmarks, whereas bond mutual funds generate significant positive global coefficients. The strong performance of bond fund managers comes from their ability to pick profitable bonds, not from their ability to time the market. Also, the empirical tests highlight that the best (worst) bond funds in the past remain at the top (bottom) of the ranking in the following years. These findings suggest that the Tunisian bond market presents strong opportunities for sophisticated investors.     

Investing in mutual funds when returns are predictable

This paper forms investment strategies in US domestic equity mutual funds, incorporating predictability in (i) manager skills, (ii) fund risk loadings, and (iii) benchmark returns. We find predictability in manager skills to be the dominant source of investment profitability—long-only strategies that incorporate such predictability outperform their Fama-French and momentum benchmarks by 2 to 4%/year by timing industries over the business cycle, and by an additional 3 to 6%/year by choosing funds that outperform their industry benchmarks. Our findings indicate that active management adds significant value, and that industries are important in locating outperforming mutual funds.     

Risk-taking and performance of government bond mutual funds

This paper investigates the risk exposures of government bond mutual funds and how risk-taking behavior affects fund performance. Government bond mutual funds often outperform their respective benchmark bond indexes before but not after adjusting for bond market risk factors. We show that the risk-taking behavior of fund managers helps to explain the different performances of government bond funds with and without controlling for the risk factors. Our results suggest that risk-taking leads to higher returns relative to benchmarks in normal risk periods but lower returns in high risk periods, suggesting that fund managers consistently take risky bets in fund management. We further show that the risk-taking of government bond funds is persistent and that investors typically have no ability to differentiate between the skill and risk components of fund performance. These findings suggest why fund managers have incentives to take consistently risky positions.     

Careers and Survival: Competition and Risk in the Hedge Fund and CTA Industry

Investors in hedge funds and commodity trading advisors (CTAs) are concerned with risk as well as return. We investigate the volatility of hedge funds and CTAs in light of managerial career concerns. We find an association between past performance and risk levels consistent with previous findings for mutual fund managers. Variance shifts depend upon relative rather than absolute fund performance. The importance of relative rankings points to the importance of reputation costs in the investment industry. Our analysis of factors contributing to fund disappearance shows that survival depends on absolute and relative performance, excess volatility, and on fund age.