Performance of Mutual Funds

Abstract

Net return of the average mutual fund in most countries and periods is below benchmark. Any fund manager skill is offset by fund expenses and fees. At best, outperformance by mutual funds occurs at the margins and in specialist applications Incentives for fund managers and other investment analysts are weakly directed towards maximising fund return Profits by mutual funds and finance firms are high relative to their economic contribution Investors’ agents contribute to emergence of financial scams, so that finance is the only sector where leading firms have received multi-billion dollar fines for defrauding their customers. The industry may face an ethical crisis. The mutual fund sector can be interpreted through the structure-conduct-performance (SCP) paradigm: A structural feature of markets is investors’ inability to predict returns, which leads mutual funds to base their revenue around funds under management. Thus fund employees and agents are compensated for growing FUM, which diverts their efforts away from maximising client returns. Fund clients are disengaged, information asymmetry obscures the quality of investment management, opacity of fund activities prevents close scrutiny, and observers and regulators provide weak oversight. This leaves mutual funds virtually free to self-regulate. Moral hazard induced by fee-based commissions leads agents with a weak ethical compass to exploit the trust and indifference of their client principals.