The Value Added from Investment Managers: an Examination of Funds of REITs

This article focuses on the specialized class of mutual funds that only invest in REITs. These funds are essentially a mutual fund of mutual funds and should only exist if fund managers have superior ability to select REITs or to time movements in the real estate market. Our empirical analysis shows that, contrary to almost all other mutual fund studies, the average and median alphas (net of expenses) are positive using the standard methodology from previous mutual fund studies. This finding is not sensitive to the type of equity return generating process assumed, but it is sensitive to the real-estate factor employed. Although we find mixed evidence that positive REIT fund alphas are persistent, we are able to offer a plausible explanation of this. Using an extension of the standard methodology to an endogenously determined time-varying regression model, we find that positive alphas are much more likely to occur when the overall market is performing poorly. This suggests that managers add more value in down markets than in up markets. Finally, we examine the cross-sectional determinants of both standard alphas and the average of time-varying alphas and find that both increase with assets and turnover. Contrary to the usual result, we find that, cross-sectionally, actively managed funds have higher alphas than passively managed funds.