ARE FUND MANAGERS SKILLED OR IS IT SIMPLY LUCK? A CASE OF ENERGY MUTUAL FUNDS

Abstract

Fund managers often tout that the performance of the funds they manage is due to their wisdom and management skills. The success in convincing the investors to this notion enables them to claim a higher salary and perks for themselves and charge a hefty or premium fee from the investors for the company they work for. However, changes in government policies, as well as in domestic and international market conditions, often influence the performance of the funds they manage. Suppose investors are not aware of this phenomenon. In that case, they may end up unnecessarily paying a hefty fee to the fund managers and investing in the wrong stock or mutual fund thereby suffering a loss in terms of the return on investment and capital loss. So, the investors must know whether the performance of any funds is due to the wisdom or skills of the fund managers or simply due to some exogenous factors beyond their control, which, in this study, we call luck. In this study, we apply the so-called Fama and French's bootstrap simulation method to determine whether the observed value of alpha – a measure of the fund’s performance – is due to fund managers’ skill or simply luck using data on monthly returns of the fifteen Equity Energy mutual funds from January 2024 through June 2019. This method involves computing a distribution of t(alpha) estimates of actual fund returns and comparing it to the performance of a cloned population of lucky funds with their true alphas set to zero. If actual funds produce higher values of t (alpha)s than the cloned population of lucky funds, then fund managers do have the skill. This distinction between skill and luck is crucial, as funds can do well or poorly by luck. Our study shows that funds can produce extreme alpha values just by luck, even if the fund's true alpha is zero. This implies that long-term investors are better off holding market portfolio ETFs and earning market return rather than paying more in fees and overall costs in attempts to beat the market. JEL classification: G1