Practical Applications of Mutual Fund Returns and Their Characteristics:A Simple Approach to Selecting Better-Performing Actively Managed Funds

Abstract

In <b>Mutual Fund Returns and their Characteristics: <i>A Simple Approach to Selecting Better-Performing Actively Managed Funds</i></b>, from the April 2020 edition of <b><i>The Journal of Investing</i></b>, <b>Burton G. Malkiel</b> of <b>Princeton University</b> and <b>Atanu Saha</b> of <b>Econ One Research</b> discuss which mutual-fund attributes best predict future fund returns. The authors find that fund selection guided by a combination of characteristics—low turnover rates, low expense ratios, and high Sharpe ratios—can lead to portfolios that considerably outperform the average actively managed fund. The authors use a robust dataset comprising prices on US and international equity funds from 2000 to 2018. They investigate the persistence of fund attributes—fund <i>age</i>, <i>size</i>, <i>net asset flows</i>, <i>prior-year</i><i>returns</i>, <i>turnover rates</i>, <i>Sharpe ratios</i> and <i>expense ratios</i>—in auguring future returns, both year-over-year and longer term. While verifying that expense ratios are significant predictors of a fund’s future returns, they stress that Sharpe ratios and turnover rates are even more predictive. Investors are encouraged to apply all three traits together to build better-performing fund portfolios. Moreover, these cost and risk-control characteristics persist enough to enable investors to dependably detect funds with extended, and statistically significant, above-average returns. <b>TOPICS:</b>Portfolio theory, portfolio construction, style investing