Abstract
This paper examines style drift and alphas for a sample of 110 international retail funds offered to individual investors. We show that when fund managers “deviate” from their stated categories, alphas are biased upward. While previous studies in the international stock arena typically employ theoretical constructs to benchmark fund performance, we employ an actual investable vehicle (tradeable ETFs) in the same categories as the funds. For the period 2002-2020, we show empirically that managers do indeed deviate from their stated fund categories with subsequent upward bias to their fund alphas. For over half of the funds in our sample, we find significant drift to emerging markets and to the US equity market. We observe that alpha is biased upward an average of 86 basis points for the retail funds examined in this study.
Highlights
The investment objective for each mutual fund must be disclosed in the fund prospectus
Our results show that for the sample period from September 2002 to November 2020, over 70 % (81/110) of our funds have a significant coefficient on the emerging markets (EEM) ETF variable which translates into fund returns that are partially attributable to drift from their stated category (MSCI EAFE (EFA) to MSCI Emerging Markets (EEM)
This result is consistent with our first hypothesis: international mutual fund managers deviate from their stated sector to the emerging markets sector
Summary
The investment objective for each mutual fund must be disclosed in the fund prospectus. While the language used in disclosing fund objectives tends to be sufficiently broad to provide a degree of flexibility in asset management, the SEC argues that fund names are generally the first piece of information seen by investors, and that as such they can significantly impact investment decisions. This is especially a cause for concern for retail investors, previous research indicates that it is pertinent to institutional investors.
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