Mutual/Hedge Funds

Is the conventional wisdom that exchange-traded funds (ETF) are efficient, low-cost alternatives to mutual funds correct? In their September 2019 paper entitled “The Performance of Exchange-Traded Funds”, David Blitz and Milan Vidojevic evaluate the performance of a comprehensive, survivorship bias-free sample of U.S. equity ETFs. They first divide the sample into three groups: (1) broad market index trackers; (2) inverse and leveraged funds; and, (3) others. They then subdivide group 3 into equity factor subgroups (small, value, dividend, momentum, quality or low-risk) based on either their names or their empirical exposures to widely accepted factor premiums. Finally, they compare performances of value-weighted ETF groups to those of the broad U.S. stock market and specified factors, focusing on data starting January 2004 when there are at least 100 ETFs of some variety. Using trading data and descriptions for 918 U.S. equity ETFs (642 live and 276 dead by the end of the sample period) and equity factor returns during January 1993 through December  2017, they find that: Keep Reading

How well have long/short equity mutual funds done in recent years? In their April 2019 paper entitled “Hedge Funds Versus Hedged Mutual Funds: An Examination of Long/Short Funds; A Performance Update”, David McCarthy and Brian Wong present an out-of-sample update of a prior performance assessment of long/short equity mutual funds (see “Multialternative Mutual Fund Performance”). They track the same universe as the prior paper and therefore do not include funds launched after January 2013. They construct an equally weighted index of long/short equity mutual funds, rebalanced monthly. They compare performance of this index to those of the S&P 500 Total Return Index, HFRI Equity Hedge Fund Index (HFRI Index) and the Dow Jones Credit Suisse Long/Short Equity Hedge Fund Index (DJ-CS Index). Using monthly returns of 26 live, 14 dead and 4 changed (up to date of change) long/short equity mutual funds established as of January 2013 along with contemporaneous returns for benchmark indexes during July 2013 through December 2018, they find that:

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Which fund family is better, Vanguard or Fidelity? In their April 2019 paper entitled “Vanguard versus Fidelity: Multidimensional Comparison of the Index Funds and ETFs of the Two Largest Mutual Fund Families”, Chong Li, Edward Tower and Rhona Zhang compare 21 matched Vanguard and Fidelity fund pairs in five ways: (1) before-tax and after-tax performance, (2) tax efficiency, (3) cost (expense ratio, turnover and short-term redemption fees), (4) diversification and (5) benchmark tracking precision. They consider 10 domestic equity and international equity index mutual funds and 11 sector exchange-trade funds (ETF). Their objective is to aid investors in selecting a fund provider. Using fund performance, cost, holdings and benchmark as of the end of 2018, they find that: Keep Reading

Do retail investors rationally account for risks as modeled in academic research when choosing actively managed equity mutual funds? In their March 2019 paper entitled “What Do Mutual Fund Investors Really Care About?”, Itzhak Ben-David, Jiacui Li, Andrea Rossi and Yang Song investigate whether simple, well-known signals explain active mutual fund investor behavior better than academic asset pricing models. Specifically, they compare abilities of Morningstar’s star ratings and recent returns versus formal pricing models to predict net fund flows. They consider the Capital Asset Pricing Model (CAPM) and alphas calculated with 1-factor (or market-adjusted), 3-factor (plus size and book-to-market) and 4-factor (plus momentum) models of stock returns. They consider degree of agreement between signals for a fund (such as number of Morningstar stars and sign of a factor model alpha) and the sign of net capital flow for that fund. They also analyze spreads between net flows to top and bottom funds ranked according to Morningstar stars and fund alphas, taking the number of 5-star and 1-star funds to determine the number of top-ranked and bottom-ranked funds, respectively. Using monthly returns and Morningstar ratings for 3,432 actively managed U.S. equity mutual funds and contemporaneous market, size, book-to-market and momentum factor returns during January 1991 through December 2011 (to match prior research), they find that:

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A subscriber inquired about a “hot hand” strategy that each year picks the top performer from a family of diversified equity mutual funds (not including sector funds) and holds that winner the next year. To evaluate this strategy, we consider Vanguard diversified equity mutual funds with inceptions no later than September 2011. The test period is the lifetime of SPDR S&P 500 (SPY), which serves as a benchmark. We assume no costs or holding period constraints/delays for switching from one fund to another. We also simplify calculations by assuming that end-of-year “hot hand” fund identification and fund switches occur simultaneously (in other words, we can accurately rank mutual funds one day before the end of the year). Using monthly total returns for SPY and for Vanguard diversified equity mutual funds as available during December 1992  through December 2018, we find that:

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Does combining the wisdom of multiple stock-picking models via ensemble methods, as done in forecasting landfall of hurricanes, improve investment portfolio performance? In their September 2018 paper entitled “Ensemble Active Management”, Alexey Panchekha, Robert Tull and Matthew Bell test the application of ensemble methods to active portfolio management, looking for consensus or near-consensus among multiple, independent stock picking sources. Ensemble diversification tends to neutralize biases among individual sources when: (1) sources are independent; (2) sources employ different approaches; and, (3) most sources achieve at least 50% individual accuracies. As sources, they use the holdings and weights of 37 actively managed U.S. equity large-capitalization mutual funds, focusing on high-conviction stock selections (those with large mismatches with respect to market capitalization). Specifically, every two weeks they:

• Reform 30,000 randomly generated clusters of 10 mutual funds.
• For each cluster, reform a long-only Ensemble Active Management (EAM) portfolio consisting of the 50 stocks with the highest consensus overweights within the cluster.
• Calculate total returns for EAM portfolios, their respective clusters and the S&P 500 Index.

They debit performance of each EAM portfolio by the average contemporaneous expense ratio of the 37 mutual funds (average 0.94% across all years). To aggregate results, they calculate rolling 1-year and 3-year performances of EAM portfolios, mutual fund clusters and the index. Using daily estimated stock holdings and weights for the 37 mutual funds and associated stock prices as available during July 2007 through December 2017, they find that:

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Does recent research on active mutual fund performance challenge conventional wisdom that: (1) the average fund underperforms passive benchmarks on a net basis; and, (2) individual fund outperformance does not persist. In their September 2018 paper entitled “Challenging the Conventional Wisdom on Active Management: A Review of the Past 20 Years of Academic Literature on Actively Managed Mutual Funds”, Martijn Cremers, Jon Fulkerson and Timothy Riley review academic research on active mutual funds from the last 20 years to assess the degree to which it supports this conventional wisdom. They focus on U.S. equity mutual funds but also consider bond funds, hybrid stock-bond funds, socially responsible funds, target date funds, real estate investment trust (REIT) funds, sector funds and international funds. Based on this research, they conclude that: Keep Reading

Do active U.S. equity mutual funds beat their passive counterparts in recent years? In the September 2018 version of his paper entitled “The Historical Record on Active vs. Passive Mutual Fund Performance”, David Nanigian compares risk-adjusted annual performance of active versus passive U.S. equity mutual funds as categorized and monitored in the Morningstar Direct survivorship bias-free database. He measures rise-adjusted performance based on the Carhart 4-factor model (accounting for market, size, book-to-market and momentum factors) alpha. He considers both value-weighted (VW), based on fund assets under management at the end of the prior month, and equal-weighted (EW) combinations of funds. In addition to the full sample, he considers separately funds in the bottom fifth (quintile) of expense ratios. He also compares active and passive funds paired based on similar expense ratios. Using monthly fund data as specified during 2003 through 2017, he finds that: Keep Reading

Does appearance-based masculinity predict hedge fund manager performance? In their January 2018 paper entitled “Do Alpha Males Deliver Alpha? Testosterone and Hedge Funds”, Yan Lu and Melvyn Teo use facial width-to-height ratio (fWHR) as a positively related proxy for testosterone level to investigate the relationship between male hedge fund manager testosterone level and hedge fund performance. They each year in January sort hedge funds into tenths (deciles) based on fund manager fWHR and then measure the performance of these decile portfolios over the following year. Their main performance metric is 7-factor hedge fund alpha, which corrects for seven risks proxied by: (1) S&P 500 Index excess return; (2) difference between Russell 2000 Index and S&P 500 Index returns; (3) 10-year U.S. Treasury note (T-note) yield, adjusted for duration, minus 3-month U.S. Treasury bill yield; (4) change in spread between Moody’s BAA bond and T-note, adjusted for duration; and, (5-7) excess returns on straddle options portfolios for currencies, commodities and bonds constructed to replicate trend-following strategies in these asset classes. They collect 3,228 hedge fund manager photographs via Google image searches, choosing the best for each manager based on resolution, degree of forward facing and neutrality of expression. They use these photographs to measure fWHR as the distance between the two zygions (width) relative to the distance between the upper lip and the midpoint of the inner ends of the eyebrows (height). Using these fWHRs, monthly net-of-fee returns and assets under management of 3,868 associated live and dead hedge funds, and monthly risk factor values during January 1994 through December 2015, they find that:

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Can investors confidently pick hedge funds that will do well? In their September 2017 paper entitled “Hedge Fund Performance Prediction”, Nicolas Bollen, Juha Joenväärä and Mikko Kauppila examine the forecasting power of 26 hedge fund performance predictors identified in past research. These predictors span five categories: seven broad manager skills; four market timing skills; six systematic risks; four tail risks; and, five incentive metrics. They test the predictors individually and in combinations based on an average of rankings by category and overall. Specifically, for their main tests, they each year:

1. Sort funds into fifths (quintiles) based on one predictor or a combination of predictors as measured over the prior 24 months.
2. Randomly select several funds (baseline 15) from the top quintile to represent a feasible long-only hedge fund portfolio.
3. Hold the selected funds with initial equal weights but no interim rebalancing for one year.
4. Calculate the performance of a succession of such one-year portfolios over the sample period.

They run 1,000 trials for each predictor/combination to obtain a performance distribution. Their benchmark is an 80% allocation to the S&P 500 Total Return Index and a 20% allocation to the Vanguard Total Bond Market Index mutual fund (VBTIX), rebalanced annually. They collect data starting in January 1994 but delete the first 12 months to control for backfill bias (reporting of a successful year after the fact). As a robustness test, they repeat the analysis on two subperiods with break point at the end of February 2009. Using monthly returns after fees and characteristics for a broad sample of hedge funds during January 1995 through December 2016, they find that: Keep Reading