The Investment Performance of Mutual Funds: An Empirical Investigation of Timing, Selectivity, and Market Efficiency

Abstract

The empirical evidence in Jensen (1968, 1969) is consistent with the joint hypothesis that the Sharpe (1964)-Lintner (1965)-Mossin (1966) (hereafter referred to as SLM) capital asset pricing model is valid and that mutual fund managers on average are unable to forecast future security prices. These studies have been cited as support for the strong form of the Efficient Markets Hypothesis (EMH);' that is, whether any investor has monopolistic access to any information relevant for price formation. In recent years the capital asset pricing model has undergone extensive empirical investigation. Friend and Blume (1970) generated random portfolios from New York Stock Exchange securities to determine the usefulness of risk-adjusted performance measures. They discovered that these performance measures are dependent upon This paper evaluates mutual fund stock selectivity performance and the implications for the Efficient Markets Hypothesis (EMH) when management is simultaneously engaged in market timing activities. Both the SharpLintner-Mossin and Black models of market equilibrium are employed as benchmarks. The empirical evidence indicates that many of the funds in the sample significantly change their risk levels during the measurement interval. This behavior also results in significantly different stock selectivity performance and portfolio diversification. The evidence on selectivity performance pertinent to the EMH is mixed. * The authors are grateful to A. Chen, D. Hester, J. Hickman, N. Kiefer, E. H. Kim, P. Lau, M. Miller, E. Parzen, L. Rosenthal, G. Schlarbaum, M. Scholes, and especially M. Hartley and R. Haugen for helpful comments and discussions. This paper has also benefited from comments by an anonymous referee and discussions with participants of the Finance Workshops at the University of Chicago, State University of New York at Buffalo, and the University of Wisconsin-Madison. The first author was visiting the Graduate School of Business at the University of Chicago during this project and gratefully acknowledges their financial support. 1. For example, see Fama 1970, pp. 410-13.