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Rating mutual funds

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  • Bechmann, Ken L.

    (Department of Finance, Copenhagen Business School)

  • Rangvid , Jesper

    (Department of Finance, Copenhagen Business School)

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    Abstract

    We develop a new rating of mutual funds: the atpRating. The atpRating assigns crowns to each individual mutual fund based upon the costs an investor pays when investing in the fund in relation to what it would cost to invest in the fund’s peers. Within each investment category, the rating assigns five crowns to funds with the lowest costs and one crown to funds with the highest costs. We investigate the ability of the atpRating to predict the future performance of a fund. We find that an investor who has invested in the funds with the lowest costs within an investment category would have obtained an annual risk-adjusted excess return that is approximately 3-4 percentage points higher per annum than if the funds with the highest costs had been invested in. We compare the atpRating with the Morningstar Rating. We show that one reason why the atpRating and the Morningstar Rating contain different information is that the returns Morningstar uses as inputs when rating funds are highly volatile whereas the costs the atpRating uses as inputs when rating funds are highly persistent. In other words, a fund that has low costs one year will most likely also have low costs the following year, whereas the return of a fund in a certain year generally contains only little information about the future return that the fund will generate. Finally, we have information on the investments in different mutual funds made by a small subgroup of investors known to have been exposed to both the atpRating and the Morningstar Rating, i.e. information is provided on how investors use the two ratings. We find that investors have a clear preference for high-rated funds.

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    File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7194
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    Bibliographic Info

    Paper provided by Copenhagen Business School, Department of Finance in its series Working Papers with number 2005-6.

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    Length: 49 pages
    Date of creation: 29 Jun 2006
    Date of revision:
    Handle: RePEc:hhs:cbsfin:2005_006

    Contact details of provider:
    Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark
    Phone: +45 3815 3815
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    Web page: http://www.cbs.dk/departments/finance/
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    Related research

    Keywords: investor-cost based rating; funds;

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    References

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    1. Guercio, Diane Del & Tkac, Paula A., 2008. "Star Power: The Effect of Monrningstar Ratings on Mutual Fund Flow," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 43(04), pages 907-936, December.
    2. Malcolm Baker & Lubomir Litov & Jessica A. Wachter & Jeffrey Wurgler, 2004. "Can Mutual Fund Managers Pick Stocks? Evidence from the Trades Prior to Earnings Announcements," NBER Working Papers 10685, National Bureau of Economic Research, Inc.
    3. Blake, Christopher R. & Morey, Matthew R., 2000. "Morningstar Ratings and Mutual Fund Performance," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(03), pages 451-483, September.
    4. Christensen, Michael, 2003. "Evaluating Danish Mutual Fund Performance," Finance Working Papers 03-4, University of Aarhus, Aarhus School of Business, Department of Business Studies.
    5. Blake, Christopher R & Elton, Edwin J & Gruber, Martin J, 1993. "The Performance of Bond Mutual Funds," The Journal of Business, University of Chicago Press, vol. 66(3), pages 370-403, July.
    6. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
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