Performance measurement of high yield bond mutual funds

Purpose - The high yield debt market has evolved into a $1 trillion market over the last 25 years. The purpose of this paper is to analyze the risk‐adjusted performance of individual mutual funds that investors use to invest in this asset class. Design/methodology/approach - Conditional excess returns are calculated for individual high yield bond mutual funds. Performance persistence over time is measured and size, asset growth, asset duration, the expense ratio, turnover, and manager tenure are used to determine if differences across funds can be explained. Findings - Overall, high yield bond funds significantly underperform the CSFB high yield index by 1.6 percent on an annualized basis which is 0.5 percent more than the average expense ratio. Individually, funds do exhibit performance persistence and top ranked funds in one period outperform bottom ranked funds over the proceeding period by an average of 2.7 percent annually. However, except for the expense ratio, commonly used explanatory variables do not appear useful for explaining risk‐adjusted excess return differences across funds leaving 86 percent of the variation unexplained. Research limitations/implications - This paper examines only no‐load mutual funds that have at least ten years of return data. Historical data for the explanatory variables used to explain alpha differences are limited which constrains any long‐term definitive conclusions. Practical implications - For investors wishing to invest in this asset class, it appears that past performance does indicate future success, and investors should concentrate on the top performing funds with the lowest expense ratios. Originality/value - This paper usefully reaffirms previous evidence on the persistence of high yield bond mutual funds, but casts doubt on the viability of using standard variables other than the expense ratio to explain risk‐adjusted returns across funds.