Friday, February 02, 2007

Mutual Funds Outperform..without your money

A study mentioned in the FT suggests mutual fund managers can add value by picking stocks but fall behind as they are forced to manage investor cash-flows. In the study, Does Motivation Matter When Assessing Trade Performance? An Analysis of Mutual Funds authors Gordon J. Alexander, Gjergji Cici, and Scott Gibson conclude that:

“fund managers possess the ability to value stocks and that motivation matters when assessing trade performance. Conditioning on the size of trades and net investor flows, we find that valuation motivated buys outperformed their benchmarks by a statistically significant 2.79% in the following year. In contrast, liquidity-motivated buys underperformed by a statistically insignificant 0.41%, suggesting that fund managers were unable to beat the market when forced to invest excess cash from investor inflows. The evidence from stocks sold by fund tells a similar story. Valuation-motivated sells underperformed their benchmarks by an insignificant 0.66%. In contrast, liquidity-motivated sells outperformed by 1.55%, suggesting that fund managers were compelled to sell stocks they would have (correctly) preferred to hold longer based on valuation beliefs. These results are found to be robust to alternative methods of portfolio creation and benchmarking.”
These findings support the contention that actively managed ETF’s should have a performance advantage over mutual funds and that SEC’s proposed rule 22c-2 should have a positive impact on investors.

Taken a step futher these results might imply that closed end funds should yield superior pre-tax performance to open end funds. In addition, funds with limited investor cashflows due to size, obscurity, availability, smaller distribution channels etc might exhibit a higher propensity to outperform. Funds with tightly focused and disciplined valuation driven buy /sell rules will often have more concentrated portfolios and may accumulate inflows or sales proceeds as cash while they wait for the market to offer those higher potential valuation driven buying opportunities. These are the Funds that can add value to a portfolio, though by virtue of their valuation discipline, can look unappealing and out of step with benchmark performance in the short run.


Blogger Me said...

Very good information about mutual funds. Feel free check out my mutual funds blog.

Sun Feb 04, 08:11:00 PM 2007  

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