Download Mutual Fund Performance and Manager Style. J.L. Davis, FAJ, Jan

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
rankings.
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Mutual Fund Performance and…
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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Mutual Fund Performance and…
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 persistence based on style.
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Mutual Fund Performance and…
Data and Methodology:
Data
US Mutual Fund Database from
CRSP.
Time period: 1965-1998.
Data is free of Survivorship bias.
Explain the problem with
survivorship bias.
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Mutual Fund Performance and…
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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Mutual Fund Performance and…
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
return.
The median equity weight for
the fund year: 93 percent.
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Mutual Fund Performance and…
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+
hiHMLm+ei,t
Where,
Rit= the percentage return to fund i,
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Mutual Fund Performance and…
Rft = the U.S. T-bill rate
Rmt = the return on the CRSP value
weighted index,
SMBt = small cap return - large cap
return,
HMLt = value return – growth return.
et = the error term.
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Mutual Fund Performance and…
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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Mutual Fund Performance and…
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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Mutual Fund Performance and…
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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Mutual Fund Performance and…
were calculated for each month of
1965.
The process was repeated for each
year.
Univariate SMB and HML sorts to
form decile portfolios and bivariate
sorts to form portfolios based on
intersection of the HML and SMB
ranking.
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Mutual Fund Performance and…
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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Mutual Fund Performance and…
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
benchmark.
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Mutual Fund Performance and…
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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Mutual Fund Performance and…
therefore, an active manager should
be able to outperform such passive
strategy.
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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Mutual Fund Performance and…
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
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Mutual Fund Performance and…
Summary: Value fund did not
performed better than growth fund.
Table 2 - Three Factor Results, SMB
Sorts.
R2 close to 1.
 negative and insignificant.
Three factor model is appropriate
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Mutual Fund Performance and…
Table 3- Independent HML and SMB
sorts portfolios
Panel A:
Low- Low corresponds to largegrowth portfolio;
High-High corresponds to smallvalue portfolio
No style portfolio show reliable
abnormal profit,a tendency for value
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Mutual Fund Performance and…
funds to under perform growth fund
is clear when SMB sensitivity is held
constant.
Conclusion from Tables 1-3: Value
funds performed poorly over the
past 30 year period.
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Mutual Fund Performance and…
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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Mutual Fund Performance and…
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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Mutual Fund Performance and…
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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Mutual Fund Performance and…
Conclusion:
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 poorperforming funds;
3. Funds did not capture value
premium.
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