mutual fund performance and manager style

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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 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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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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Data and Methodology:DataUS 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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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 return.

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+

hiHMLm+ei,t

Where,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 return,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 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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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 benchmark.

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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 strategy.Results- Style Based Portfolio

Table 1- Three Factor Results, HML Sorts.

Panel A – Sorted by HML slopePanel B – Regression ResultsR2 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 HMLDeciles 7-10: value based on HMLDeciles 1-4 : positive Deciles 5-10: negative Decile 10 : (=-.2) and significant, i.e., underperformance

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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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Table 3- Independent HML and SMB sorts portfoliosPanel 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 constant.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 portfolioPanel B: Regression coefficientsPanel C: Regression results one year after formationPanel 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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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 poor-performing funds;

3. Funds did not capture value premium.

mutual fund performance and manager style

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