Performance of Investment Companies
Investment company performance has been one of the most widely studied topics in all of finance. There are two primary reasons for this: (1) These funds reflect the performance of professional money managers, and (2) fund data have been available for a long time. When Sharpe evaluated the overall performance of mutual funds, only 32 percent of the funds outperformed the DJIA. Further, comparing the ranks of the funds between the first and second halves of the sample period led Sharpe to conclude that past performance was not the best predictor of future performance. An examination of the relationship between performance and the expense ratio indicated that good performance was associated with low expense ratios. Finally, analysis of gross performance, with expenses added back to the returns, indicated that 56 percent of the funds did better than the DJIA. Therefore, Sharpe concluded that the average mutual fund manager selected a portfolio at least as good as the DJIA; but, after deducting the operating costs of the fund, most achieved net returns below those of the DJIA.
The results of a study by Jensen indicated that on average the funds earned 1.1 percent less per year than they should have earned for their level of risk. Analysis of gross returns with expenses added back indicated that 42 percent did better than the overall market on a risk adjusted basis, whereas the analysis of net returns indicated that only 34 percent of the funds outperformed the market.
The gross returns indicate the forecasting ability of the funds because these results do not penalize the funds for operating expenses (only brokerage commissions). Jensen concluded that on average these funds could not beat a buy-and-hold policy. Carlson examined the overall performance of mutual funds with emphasis on the effects of the market series used for comparison and the time period. The results depended heavily on which market series were used: the S&P 500, the NYSE composite, or the DJIA. For the total period, most fund groups outperformed the DJIA, but only a few had gross returns better than the S&P 500 or the NYSE composite. Using net returns, none of the groups outperformed the S&P 500 or the NYSE composite.
Analysis of the performance factors indicated consistency over time for return or risk alone but no consistency in the risk-adjusted performance. Less than one-third of the funds that performed above average during the first half did so in the second half. Given the growing tendency toward global stock and bond investing, several authors have examined the performance of international equity and fixed-income funds. Cumby and Glen examined the performance of international funds compared to the Morgan Stanley world equity index and a U.S. index. Using two risk-adjusted performance measures, they found no evidence that the performance of the funds surpassed that of a broad international index during the sample period. Bailey and Lim examined the performance of country funds (e.g., France, Germany, Korea, Spain) to see if these funds helped investors attain international diversification. They found that country fund returns often resembled domestic U.S. stock returns more than returns from foreign stock portfolios—that is, these funds would not provide the expected benefits of diversification. Cai, Chan, and Yamada showed that Japanese mutual funds tend to underperform their benchmarks.
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