Winner Funds Research Articles

Searching for mutual fund winners? the strategy is to outbid both, the benchmark and the peer group

ABSTRACT Standard Fama-French-Carhart models define ‘winners’ as funds that generate the highest excess returns given the factor risks involved; however, they do not provide information on whether such winners are outperforming their prospectus benchmark or their peer group. In addition, existing literature relying on these models, by and large, does not find evidence of persistence in performance. In this paper, we propose a two-stage procedure that allows investors to select ‘true’ winners(losers) which generate the highest factor-risk-adjusted performance relative to the benchmark and the peer group simultaneously. Utilizing both adjustments at the same time results in a strong predictive ability, leading to a selection of funds that persist in performance. Our true winner funds have statistically significant superior benchmark-adjusted alphas, peer group adjusted alphas and Sharpe ratios one year ahead, which are significantly different from those generated by the true loser funds. The results are robust to extended investment horizon, and alpha estimation method, and they are not driven by outliers, size of fund-sorts, or any particular period within our sample.

Mutual funds' performance and relative strength of factor exposures

PurposeThe purpose of this study is to measure mutual funds' manager performance by attributing it to their abilities to choose better securities (selectivity effect) and to allocate these securities better than their benchmarks (allocation effect). The study enables the authors to examine the relative contributions of the commonly known asset-pricing factors in mutual funds' performance.Design/methodology/approachTo examine managers' ability to steer funds' returns, the authors conduct a two-dimensional holdings-based analysis using factor-specific decomposition of funds' excess returns into their ability to select and allocate securities better than their benchmarks. Subsequently, the authors conduct an analysis of the covariance (ANCOVA) due to these factors in explaining funds' excess returns over time.FindingsWhile managers' ability to choose better securities than the benchmarks (the selectivity effect) appears modest, some funds (especially the winners) allocate securities in their portfolios better than their benchmarks (the allocation effect) based on their exposures to certain factors (e.g. the momentum factor for the winner funds). However, although funds consistently gain through their ability to predict the size and value factors well, they do not consistently possess the skills to predict the momentum factor.Research limitations/implicationsAlthough the paper analyzes all the available diversified funds, the sample excludes several other categories, such as thematic and international funds. Further, the analysis is based on equity-oriented Indian funds. Broader studies of changes in factor exposures and the inclusion of more factors apart from those conventionally used may shed more light on the managers' ability to maneuver these factors.Practical implicationsThe results show that mutual fund managers lack persistence in their performance, even though some of them could predict specific factors well. Since the activity in active mutual funds could not lead to superior performance over time, investors could be better off by selecting cheaper passive funds for their long-term investments.Originality/valueThe paper presents a novel approach to studying funds' performance by conducting a two-dimensional holdings-based analysis to capture the relative contributions of common asset-pricing factors in the cross-section as well as over time.

Top-bottom investing skill and the fund alpha in Indian mutual fund industry: an empirical investigation

PurposeMutual funds are the second most preferred investment option in India and have garnered considerable research interest. The focus of Indian studies thus far has been restricted to the bottom-up approach of investing which rewards a fund manager for picking winner stocks and generates superior returns. While changing portfolio allocation as per varying macro-trends has been instrumental in generating superior returns, it has not been given the desired attention. This study addresses this important research gap.Design/methodology/approachThe authors analyze the industry selection ability of the fund manager on a robust sample by decomposing alpha into alpha due to industry selection and alpha attributable to stock selection. Alpha estimates are computed on a robust sample of 34 open-ended Indian equity mutual funds for a 10-year duration 2011–2020 using three base models of asset pricing – single-factor, four-factor and five-factor alpha under panel data methodology.FindingsThe study leads us to four major findings. One, industry selection explains more than two-fifth of the alpha both in cross-section and time series of returns; two, industry selection exhibits persistence for more than four quarters across asset pricing model; third, younger funds have level playing when alpha from picking right industries is concerned; four, broad industry allocation continues to explain superior returns as sector allocation undergoes consolidation during ongoing COVID-19 pandemic and funds increase exposure to defensive stocks, consistent with folio allocations as per macroeconomic conditions.Research limitations/implicationsThe authors find strong evidence of persistence in the case of alpha attributable to the industry selection component, and the findings are consistent with the persistence results reported in the empirical literature. While some funds excel in stock-picking skills and others excel in picking the right industries, both skills together make for winner funds that attract larger investor flows as investors chase superior performance. The authors also find no evidence of diseconomies of scale in the case of industry allocation alpha generated by the fund managers.Practical implicationsThe results suggest a fresh approach for investors while making mutual fund investment decisions; the investors can achieve superior returns by assessing industry selection skills as it tends to provide a more holistic picture concerning a perennial question – why some funds outperform and continue to contribute to investor's wealth?Social implicationsMutual funds have become a favored investment option for Indian investors more so as a disciplined investment option owing to dismal financial literacy rates. The study throws light on a relatively unaddressed dimension of choosing winner funds. The significance of right sector allocation assumed even more significance with the onset of the pandemic which lends further credence to the findings of the study.Originality/valueResearch has been conducted on secondary data extracted from a well-cited database for Indian mutual funds. Empirical analysis and conclusion drawn are based on authentic statistical analysis and adds to the existing literature.

Hedge Fund Manager Skill and Style-Shifting

Using a novel style identification procedure, we show that style-shifting is a dynamic strategy commonly used by hedge fund managers. Three quarters of hedge funds shifted their investment styles at least once over the period from January 1994 to December 2013. We perform empirical tests of two hypotheses for the motivations of hedge fund style-shifting, namely backward-looking and forward-looking hypotheses. We find no evidence that style-shifting funds are backward-looking. Instead, we show evidence that managers of style-shifting funds exhibit both style-timing ability and the skill of generating abnormal returns in new styles. The new styles that hedge funds shift to on average outperform their old styles by 0.76% and style-shifting funds on average outperform their new style benchmark by 1.10% over the subsequent 12-month horizon. Finally, we show that small funds, winner funds, and funds with net inflows are more likely to shift styles. This paper was accepted by David Simchi-Levi, finance.

Mutual fund performance: Shouldn’t clear winners outperform both, the benchmark and the peer-group?

Standard Fama-French-Carhart models define ‘winners’ as those funds that generate highest excess returns given the factor risks involved; however they do not provide information on whether such winners are outperforming their prospectus benchmark or their peer-group. In addition, existing literature relying on these models by and large does not find evidence of persistence in performance. In this paper, we argue that true (unbiased) winners should be defined differently: they are funds placed in the top-ranking group (quartile, quintile, etc.), which generate the highest factor-risk-adjusted performance relative to the benchmark and the peer-group simultaneously. We prove in this paper that using this definition and selecting true winner funds based on benchmark- and peer-group-adjusted alphas jointly lead to better performance than selecting the funds using either of these two alphas separately. Utilising both adjustments at the same time results in a strong predictive ability, leading to a selection of funds that persist in performance: our true winner funds have statistically significantly superior benchmark-adjusted alphas, peer-group adjusted alphas and Sharpe ratios one-year-ahead, which are significantly different from those generated by the true loser funds. The results are robust to extended investment horizon, and alpha estimation method, and they are not driven by outliers, size of fund-sorts, or any particular period within our sample.

Do mutual funds have consistency in their performance?

Using a comprehensive data set of 714 Chinese mutual funds from 2004 to 2015, the study investigates these funds’ performance persistence by using the Capital Asset Pricing model, the Fama-French three-factor model and the Carhart Four-factor model. For persistence analysis, we categorize mutual funds into eight octiles based on their one year lagged performance and then observe their performance for the subsequent 12 months. We also apply Cross-Product Ratio technique to assess the performance persistence in these Chinese funds. The study finds no significant evidence of persistence in the performance of the mutual funds. Winner (loser) funds do not continue to be winner (loser) funds in the subsequent time period. These findings suggest that future performance of funds cannot be predicted based on their past performance.

Mutual Fund Performance When It Really Matters Most

Motivated by asset pricing evidence that disappointment periods in aggregate consumption growth are very good proxies for high marginal utility states, we examine whether equity fund performance exhibits state dependence. We find that the quintile of funds with the highest (lowest) unconditional CAPM alpha exhibits the biggest decrease (increase) in risk-adjusted performance during disappointment months. As a result, the alpha differential between unconditional winner and loser funds disappears when it matters most in utility terms. Our results indicate that the unconditional CAPM alpha is a highly misspecified performance measure from the viewpoint of a disappointment averse investor. To the contrary, state dependence is considerably attenuated when the 3-factor Fama-French alpha is used as performance measure. We conclude that the latter is the least misspecified unconditional performance measure, as it better aligns managerial incentives with the preferences of a disappointment averse investor. These findings are particularly important for fund performance measurement in light of the recent evidence that investors primarily evaluate funds on the basis of their CAPM alpha.

Performance attribution of mutual funds in India: outperformance or mis‐representation?

AbstractWe conduct a novel holdings‐based performance attribution, particularly suited to emerging markets, for equity‐oriented active mutual funds in India. Although, we find significantly positive alphas for an average fund, the stated benchmarks are grossly mis‐specified. A style‐adjusted benchmark could beat the stated benchmarks by greater margins than the funds themselves. While funds’ trading activity consistently adds value, cash drag and market timing usually diminish value. Although, the best‐performing funds exhibit superior security selection abilities, their outperformance does not persist. However, despite the lack of persistence winner funds continue to generate significantly higher alphas than loser funds for quite some time.

Benchmark-adjusted performance of US equity mutual funds and the issue of prospectus benchmarks

This study examines the impact of mismatch between prospectus benchmark and fund objectives on benchmark-adjusted fund performance and ranking in a sample of 1281 US equity mutual funds. All funds in our sample report S&P500 index as a prospectus benchmark, yet 2/3 of those are placed in the Morningstar category with risk and objectives different to those of the S&P500 index. We identify more appropriate ‘category benchmarks’ for those mismatched funds and obtain their benchmark-adjusted alphas using recent Angelidis et al. (J Bank Finance 37(5):1759–1776, 2013) methodology. We find that S&P500-adjusted alphas are higher than ‘category benchmark’-adjusted alphas in 61.2% of the cases. In terms of fund quartile rankings, 30% of winner funds lose that status when the prospectus benchmark is substituted with the one better matching their objectives. In the remaining performance quartiles, there is no clear advantage of using S&P 500 as a benchmark. Hence, the prospectus benchmark can mislead investors about fund’s relative performance and ranking, so any reference to performance in a fund’s prospectus should be treated with caution.

Do Hedge Funds Ride Market Irrationality?

Utilizing a novel style identification procedure, we show that style-shifting is a dynamic strategy commonly employed by hedge fund managers. Three quarters of hedge funds shifted their investment styles at least once over the period from January 1994 to December 2013. We perform empirical tests of two hypotheses for the motivations of hedge fund style-shifting, namely backward-looking and forward-looking hypotheses. We find no evidence that style-shifting funds are backward-looking. Instead, we show evidence that managers of style-shifting funds exhibit both style-timing ability and the skill of generating abnormal returns in new styles. The new styles that hedge funds shift to on average outperform their old styles by 0.76% and style-shifting funds on average outperform their new style benchmark by 1.10% over the subsequent 12-month horizon. Finally, we show that small funds, winner funds, and funds with net inflows are more likely to shift styles.

Hedge Fund Manager Skills and Style-Shifting

Utilizing a novel style identification procedure, we show that style-shifting is a dynamic strategy commonly employed by hedge fund managers. Three quarters of hedge funds shifted their investment styles at least once over the period from January 1994 to December 2013. We perform empirical tests of two hypotheses for the motivations of hedge fund style-shifting, namely backward-looking and forward-looking hypotheses. We find no evidence that style-shifting funds are backward-looking. Instead, we show evidence that managers of style-shifting funds exhibit both style-timing ability and the skill of generating abnormal returns in new styles. The new styles that hedge funds shift to on average outperform their old styles by 0.76% and style-shifting funds on average outperform their new style benchmark by 1.10% over the subsequent 12-month horizon. Finally, we show that small funds, winner funds, and funds with net inflows are more likely to shift styles.

Mutual Fund Performance: An Approach to Identifying the Top Performing Funds

Two recent augmentations of standard factor models in the literature enable investors to compute benchmark-adjusted alphas (Angelidis et al., 2013) and peer-group adjusted alphas (Hunter et al., 2015). We show that by and large the funds placed in the top performance quartile using either one of these models do not produce statistically significantly higher Sharpe ratios than the funds in the bottom quartile one year ahead. However, we find that the joint predictive ability of these models is strong: using both models at the same time to select the winner funds produces statistically significantly superior Sharpe ratios one-year ahead.

Performance and Persistence in Performance of Actively Managed Chinese Equity Funds

The aim of this study is to analyze performance of mutual funds of biggest emerging economy i.e. China. Examining Chinese mutual funds’ performance provides an opportunity to assess the ability of fund managers to outperform the benchmark market. We study the equity mutual funds of China by taking the sample of 707 funds for the period from 2004 to 2015 and evaluate their performance using Capital Asset Pricing Model, Fama–French three factor model and Carhart four factor model. It is found that mutual funds in China give better return than the benchmark market return which means that active management pays better than passive management in mutual fund industry. Moreover, this study also investigates the existence of persistence in the performance of mutual funds and findings indicate that mutual funds in China are not consistent in their performance. Winner (Top-Performing) funds of last year do not continue to be winner funds in the following year and loser funds of previous year give better return in the following year. Overall findings indicate the non-existence of persistence in the performance of Chinese mutual funds.

Bootstrapping and Inflation Hedging Performance of Korean Equity Funds

This paper examines the inflation hedging performance separated into expected and unexpected inflation in Korean equity funds. In particular, using the bootstrap approach, we identify whether the inflation hedging performance is based on skill or luck. We use the equity funds of the average net asset value (NAV) over 5 billion Korean won and over the 80% stock position. The sample data cover the period from January 2002 to March 2015. The main findings are as follows. First, most equity funds demonstrate a hedging performance against the unexpected inflation shock and this hedging performance seems to come from the fund manager’s skill. Second, our findings are robust across the sieve bootstrap results for the serial dependence and heteroscedasticity. Third, the equity funds have slightly different inflation hedging performances depending on their investment style. Among the investment styles, small-cap, growth, or small and growth style funds demonstrate more hedging performance against unexpected inflation shock. This hedging performance seems to come from the fund manager’s skill. Finally, in the case of the funds separated by winner and loser, the winner funds have more hedging performance for unexpected inflation shock than the loser funds.

The Impact of Benchmark Choice on US Mutual Fund Benchmark-Adjusted Performance and Ranking

This study re-visits the question of benchmark mismatch among 1281 US equity mutual funds and its impact on benchmark-adjusted fund performance and ranking. All funds report S&P500 index as a prospectus benchmark, yet 2/3 of those are placed in the Morningstar category with risk and objectives different to those of the S&P500 index. We identify ‘true’ benchmarks for those mismatched funds and find that their S&P adjusted alphas are higher than ‘true’ benchmark adjusted alphas in 61.2% of the cases. In terms of fund quartile rankings, 30% of winner funds lose that status when the prospectus benchmark is substituted with a more suited one. In the remaining performance quartiles there is no clear advantage of using S&P 500 as a prospectus benchmark. The prospectus benchmark therefore can mislead investors about fund’s relative performance. This leads us to conclude that any reference to performance in a fund’s prospectus should be treated with caution.

UK Mutual Fund Performance Persistence with Active Peer Benchmarks

We assess UK mutual fund performance from a perspective of a peer-group, applying a novel approach suggested in Hunter et al. (2014). Our sample comprises of 817 UK long-only active equity mutual funds allocated to nine Morningstar style category peer-groups in the period 1992-2016. Overall, we find that those funds with most significant positive peer-group adjusted alphas continue to perform well one-year-ahead, using both parametric and non-parametric measures of persistence in performance. Further, a small increase in significance of peer-group adjusted alphas significantly improves the probability that a fund will be placed in the top quartile in the following period. Finally, we document that persistence in performance is driven by both winner and loser funds. The results within each peer group by and large conform to these findings.

Do Persistent Fund Alphas Indicate Manager Skill?

This article examines whether long-term fund alphas come from manager skill or luck. Using a group of bootstrapped winner funds as the benchmark, we compared the actual winner funds with the benchmark. We find evident differences between them with regard to return distribution properties, market exposure, alpha consistency, and portfolio holdings. In addition, persistent winner funds exhibit fund-specific characteristics that are distinct from those of other funds. We conclude that persistent fund alpha is earned by manager skill instead of pure luck.

Market states and mutual fund risk shifting

PurposeThe purpose of this paper is to explore the motivation behind mutual funds’ risk shifting behavior by examining its impact on fund performance, while jointly considering fund managers’ compensation incentives and career concerns.Design/methodology/approachThe study uses a sample of US actively managed equity funds over the period 1980-2010. A fund’s risk shifting is estimated as the difference between the fund’s intended portfolio risk in the second half of the year and the realized portfolio risk in the first half of the year. Using the state of the market to identify the dominating type of incentive that fund managers face, we examine the relationship between performance and risk shifting in a cross-sectional regression setting, using the Fama and MacBeth (1973) methodology.FindingsThe authors find that poorly performing (well performing) funds are likely to increase (decrease) their risk level in bull markets, while reducing (increasing) it during bear markets. Furthermore, we find that funds that increase risk underperform, while those that decrease their portfolio risk do not. In addition, we find that poorly performing funds that increase (or decrease) their risk underperform across bull and bear markets, while well performing funds that reduce risk during bull markets subsequently outperform.Originality/valueThe paper contributes to the literature on mutual fund risk shifting by providing evidence that the performance consequence of such behavior is dependent on the state of the market and on the funds’ past performance. The results suggest that loser funds tend to be agency prone or be managed by managers with inferior investment skill, and that winner funds exhibit superior investment ability during bull markets. The authors argue that both the agency and investment ability hypotheses are driving fund managers’ risk shifting behavior.

Fund Flows, Manager Changes, and Performance Persistence*

Most empirical studies suggest that mutual funds do not persistently outperform an appropriate benchmark in the long run. We analyze this lack of persistence in terms of two equilibrating mechanisms: fund flows and manager changes. Using data on actively managed US equity mutual funds, we find that if neither mechanism is operating, winner funds (top-decile ranked in previous year) continue to significantly outperform loser funds (bottom-decile ranked in previous year) by 4.08 percentage points per annum. However, the difference between previous winner and loser funds declines to zero within one year if the two mechanisms are acting together. Thus, equity mutual fund out- and underperformance are unlikely to persist in well-functioning financial markets.

Fund Flows, Manager Change and Performance Persistence

Most empirical studies suggest that mutual funds do not persistently outperform an appropriate benchmark in the long run. We analyze this lack of persistence in terms of two equilibrating mechanisms: fund flows and manager changes. Using data on actively managed U.S. equity mutual funds, we find that if neither mechanism is operating, winner funds (top-decile ranked in previous year) continue to significantly outperform loser funds (bottom-decile ranked in previous year) by 4.08 percentage points per annum. However, the difference between previous winner and loser funds declines to zero within one year if the two mechanisms are acting together. Thus, mutual fund out- and underperformance is unlikely to persist in well-functioning markets.