Mutual fund performance appraisals: a multi-horizon perspective with endogenous benchmarking

With over 6500 mutual funds available to investors, industry data show that consumers pay a great deal of attention to the ratings of mutual funds. In spite of this attention, however, much controversy surrounds the various industry approaches to the rating of mutual funds. Many industry rating approaches use subjective weights to integrate fund performances over different time horizons; this can give rise to quite different ratings, depending upon the relative importances assigned to different horizons. In this paper, we present two basic quadratic programming approaches for identifying those funds that are strictly dominated, regardless of the weightings on the different time horizons being considered, relative to their mean returns and risks. This effort can be viewed as a novel application of the philosophy of data envelopment analysis, a relatively new, non-parametric frontier estimation technique which focuses on estimating 'radial' contraction/expansion potentials. These approaches eliminate any need for subjective tradeoffs, vis-á-vis the importance or meaningfulness of performances over the different horizons. Finally, much useful sensitivity information is automatically provided. Also, in contrast to many studies of mutual fund performance, our approaches endogenously determine a custom-tailored benchmark portfolio to which each mutual fund's performance is compared. All of our approaches are illustrated on a sample of twenty-six actual mutual funds.