In Chapter 1 the authors examine the performance of Canadian mutual fund managers, and find that their performance is indifferent when com- pared with some well-recognized bench marks such as the TSE 300 and the 90-day T-Bill rates, and is even lower when one accounts for the timing of entry and exit by mutual fund investors. They attribute this to the lack of performance persistence.
However, unlike some US studies, they do not find evidence suggesting that Canadian mutual fund investors chase winners and are reluctant to exit from losing funds; while investors do allo- cate funds based on past performance, the allocations do not favor star funds disproportionately. Poor performers experience significant fund withdrawals. They attribute this to the differences in the tax treatment of retirement-related savings – the principal source of mutual funds asset growth.
Chapter 2 applies data envelopment (DEA), a mathematical programming technique, to measure the performance of equity retail funds in New Zealand over the period 1998–2003. An analysis of fifty-two equity mutual funds, national and international, shows significant differences in their performances, with an average DEA efficiency score of 0.72. Applying regression analysis further shows that funds with an international asset allocation strategy have had lower efficiency scores, and that larger funds have had higher efficiency scores.
Chapter 3 examines Danish mutual funds. The authors describe what is special about Danish mutual funds, as well as the dimensions along which Danish funds are comparable to other European funds. They discuss how Danish mutual funds have performed in absolute terms and in relation to other European mutual funds, and focus also on the costs to the investor of purchasing Danish mutual funds certificates. Finally, the authors compare Danish fund costs with the mutual fund costs in other European countries.
Chapter 4 discusses the recent evidence suggesting that behind invest- ment strategies there is a latent philosophy featuring the market in which money managers operate. Starting from this insight, the study explores the styles and performance of Italian managers over the period 1999–2004, making as clear as possible all the significant idiosyncrasies the authors find by scrutinizing the return patterns over time.
Chapter 5 aims to supplement the existing literature on Spanish equity mutual funds’ seasonality and how it is related to the relative performance of these funds. In addition, the authors investigate whether there is any empirical evidence of window-dressing or performance hedging strategies in their sample.
Chapter 6 investigates the relationship between fees and performance in the US market for domestic equity mutual funds. The analysis shows that price and quality have been related negatively in this market during the period 1992–2003. The result holds for different measures of performance, across fund categories, and across time periods, with a single exception: the dot-com bubble, when more expensive funds delivered higher-than- average abnormal returns.
Chapter 7 examines a set of performance measures derived for the general case of mean-risk-preferences based on a portfolio-theoretical frame- work. As an application of general analysis, the authors use Yaari’s dual theory of choice to develop a specific “measure of dual risk,” which leads to the consideration of generalized Gini mean differences. The authors contrast the resulting performance measures with performance evaluations in the case of traditional mean-variance and mean-variance-skewness analysis via an empirical study of the German capital market.
Chapter 8 examines the efficiency of large US stocks, bonds and balanced funds using a data envelopment analysis (DEA) approach. The author uses different DEA models to rank and compare their efficiency, and then compares the efficiency of the funds of the various DEA models with the well-known risk-adjusted measure known as the Sharpe ratio.
Chapter 9 analyzes the persistence of Irish mutual funds using a contingency table methodology. The authors find little evidence of performance, but discover that risk adjustments are important in evaluating performance.
Chapter 10 investigates whether it is possible to reconcile ethical and financial performance? Using a new measure of ethical strength, the authors find that US equity mutual funds exhibit a highly significant negative relation between the two, suggesting the existence of ethical costs. Ethical funds seem able, nevertheless, to compensate ethical costs with superior financial performance.
Chapter 11 is concerned with the development and current structure of the German market, and provides an overview of the products offered. The chapter also outlines possible consequences of the changing market structure for the future development of the German fund market.
Chapter 12 examines the relationship between mutual investment fund size and fund financial performance, using the Spanish mutual fund mar- ket. The results of the chapter show that there is a relationship between fund size and performance consistent with the past literature.
Returns and Fund Flows in Canadian Mutual Funds
With nearly $440bn in assets and 51 million account holders by the end of the year 2003 in Canada, mutual funds now occupy a prominent position among financial intermediaries. The 1990s witnessed an explosive growth in mutual funds in Canada; the number of accounts grew nearly tenfold during this period. A similar growth in mutual fund assets has been reported in many countries around the world.
This phenomenal growth notwithstanding, there are serious concerns about the value added by mutual funds, and the ability of investors to earn superior risk-adjusted returns. The pioneering work of Jensen (1968) and the more recent works by Malkiel (1995), Elton et al. (1996) and Gruber (1996) of US-based mutual funds cast a long shadow over the ability of money managers to add value. Studies by Odean (1998) of investors’ trad- ing activity, and Sirri and Tufano (1998) of fund flows also suggest that investors are being seriously short-changed by their proclivity to chase winners and their reluctance to let go of losers.
The finding that mutual fund investors chase above-average performing funds (Sirri and Tufano, 1998), are reluctant to book losses (Odean, 1998), and the evidence on declining performance persistence amongst mutual funds (Malkiel, 1995) raises the possibility that returns to mutual fund investors (IRR) may be lower than returns reported by mutual funds (RR). This study provides the first-ever evidence on the magnitude of the difference between IRR and RR for mutual fund investors. We also test for the asymmetric relationship between past performance and subsequent funds flow, using panel data techniques.
The study is organized as follows: Section 1.2 provides a brief literature review of the discussion on mutual funds and the trading behavior of mutual fund investors. Section 1.3 examines some methodological and measurement issues that underpin the validity of the findings. Section 1.4 discusses the sample; section 1.5 reports the findings; and section 1.6 concludes the study.
1.2 LITERATURE ON PERFORMANCE AND TRADING BEHAVIOR OF MUTUAL FUNDS
A number of studies have examined the performance of mutual funds (Jensen, 1968). While these studies have typically concentrated on the reported returns by mutual funds, three strands of literature lead to the possibility that the IRR may be lower than RR. The first group of studies analyzes the sensitivity of capital flows into funds as a function of performance. Studies by Chevalier and Ellison (1997), Sirri and Tufano (1998) provide extensive evidence in support of an inverse relationship between past performance and current fund flows. Odean (1998), in a study of trad- ing behavior of more than 30,000 households, found that investors used past returns as a positive signal of fund quality and future performance. This has been referred to as “representative heuristic” in behavioral finance. An above-average performance by a mutual fund in the previous year is likely to induce a greater inflow of funds in the current year.
The strategy of investing in out-performing funds has been described as the “hot hands” phenomenon. Hendricks et al. (1993), Goetzmann and Ibbotson (1994) and Brown and Goetzmann (1995) suggest that mutual funds showing above-average performance in one period will follow it up with an above-average performance in the following period. Thus, accord- ing to these studies, mutual fund investors will get higher returns if they choose mutual fund investors that are past winners. However, Malkiel (1995) in a study of US mutual funds, found that while there appeared to be persistence of returns in the 1970s, there was no similar significant persistence during the 1980s. In the 1980s, the performance decay was characteristic, and past performance was no predictor of future performance. The evidence on persistence is important for the IRR and RR relationship. IRR will be greater than RR if there is performance persistence, and less than RR in the absence of performance persistence.
Finally, a study by Odean (1998) documents the reluctance by investors to realize losses. This loss aversion will have the implication of widening the gap between RR and IRR. Using a unique data set on the trading behavior of 30,000 households, Odean (1998) found that investors are reluctant to realize losses by selling under-performing funds. This is an example of the disposition effect (Shefirin and Statman, 1985). The combined implication of the evidence on investors chasing past winners, lack of performance persistence and reluctance to realize losses will be that the IRR is lower than RR.
Nesbitt (1995) examined the impact of market timing by mutual fund investors, by compiling the dollar-weighted returns of seventeen categories of mutual funds, and found that the dollar-weighted returns were less than the time-weighted returns for every category of mutual funds. Nesbitt concluded that investors suffer a shortfall in return because of the ill-timed movement of funds.