Mutual Fund Systematic Risk for Bull and Bear Markets: An Empirical Examination

Abstract

THE QUESTION OF THE STABILITY of the systematic risk, or beta coefficient, for mutual funds over bull and bear market conditions has been debated in the literature [22, 23, 24, 25, 28, 29]. The issue is particularly relevant when evaluating the market-timing and security selection ability of the fund manager. If beta does differ with market conditions, the use of beta estimated from the entire period can result in different conclusions about the skills of the fund manager under different market conditions. For example, suppose that a fund manager correctly adjusts the fund's beta in anticipation of a bull market. Hence, the beta for the bull period would be greater than the beta estimated from using both bull and bear market periods. If the beta for the entire time period is employed to evaluate investment performance, good investment performance in the bull period may be due solely to market-timing ability rather than security selection ability. By using the beta for the entire time period, no allowance is made for the increased risk exposure. In order to properly test for the security selection ability, the bull period beta should be employed if it differs from the beta for the entire period.' The purpose of this paper is to test whether the betas for 85 open-end investment companies (called simply mutual funds hereafter) differ in bull and bear market periods.2 The next section explains the statistical model that will be used in this study. In the third section the data base and bull-bear market definitions are described. The results are presented in the fourth section. Section V contains conclusions. * Associate Professor of Finance, Hofstra University and Professor of Economics and Finance, B. M. Baruch College, CUNY. We wish to thank the referee for his helpful comments. 'To illustrate this point, let b, denote the portfolio data for the i-th mutual fund over the entire period and b, denote the beta for the bull market data for the same mutual fund. Using the capital asset pricing model, the expected return in the bull market based on beta for the entire period is: