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Investing in mutual funds when returns are predictable

  • Avramov, Doron
  • Wermers, Russ
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    This paper analyzes the performance of portfolio strategies that invest in noload, open-end U.S. domestic equity mutual funds, incorporating predictability in (i) manager skills, (ii) fund risk-loadings, and (iii) benchmark returns. Predictability in manager skills is found to be the dominant source of investment profitability - long-only strategies that incorporate such predictability considerably outperform prior-documented hot-hands and smart-money strategies, and generate positive and significant performance with respect to the Fama-French and momentum benchmarks. Specifically, these strategies outperform their benchmarks by 2-4% per year through their ability to time industries over the business cycle. Moreover, they choose individual funds that outperform their industry benchmarks to achieve an additional 3-6% per year. Overall, our findings indicate that industries are important in locating outperforming mutual funds, and that active management adds much more value than documented by prior studies.

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    File URL: http://econstor.eu/bitstream/10419/57727/1/69992278X.pdf
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    Paper provided by University of Cologne, Centre for Financial Research (CFR) in its series CFR Working Papers with number 05-13.

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    Date of creation: 2005
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    Handle: RePEc:zbw:cfrwps:0513
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    Web page: http://cfr-cologne.de/english/version06/html/home.php
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    1. Pastor, Lubos & Stambaugh, Robert F., 2002. "Investing in equity mutual funds," Journal of Financial Economics, Elsevier, vol. 63(3), pages 351-380, March.
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    19. Admati, Anat R, et al, 1986. " On Timing and Selectivity," Journal of Finance, American Finance Association, vol. 41(3), pages 715-30, July.
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    21. Erik R. Sirri & Peter Tufano, 1998. "Costly Search and Mutual Fund Flows," Journal of Finance, American Finance Association, vol. 53(5), pages 1589-1622, October.
    22. Doron Avramov, 2004. "Stock Return Predictability and Asset Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 17(3), pages 699-738.
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