08.05.09

Another reason not to invest in actively-managed mutual funds

Posted in All Categories at 9:25 am by Michael Goode

A new paper (False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas) up on SSRN finds evidence that mutual fund manager ‘alpha’ or skill has decreased over time. Here is the abstract:

This paper develops a simple technique that controls for “false discoveries,” or mutual funds that exhibit significant alphas by luck alone. Our approach precisely separates funds into (1) unskilled, (2) zero-alpha, and (3) skilled funds, even with dependencies in cross-fund estimated alphas. We find that 75% of funds exhibit a zero alpha (net of expenses), consistent with the Berk and Green (2004) equilibrium. Further, we find a significant proportion of skilled (positive alpha) funds prior to 1996, but almost none by 2006. We also show that controlling for false discoveries substantially improves the ability to find funds with persistent performance.

For long-term performance, the authors found 1565 funds with zero alpha (net of fees), 499 with negative alpha (net of fees), and only 12 funds with positive alpha (net of fees; data from Table 2 on page 37).

Download the full paper at SSRN.

Disclosure: Except for a small position in DODFX, all of my and my wife’s long-term stock investments are in index funds.

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