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Mutual Fund Misclassification: Evidence Based on Style Analysis

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  • Dan diBartolomeo
  • Erik Witkowski

Abstract

An iterative application of William Sharpe's method of style analysis is applied to the classification of equity mutual funds. A new methodology for creating purified mutual fund style indexes is used to verify existing classifications. Results suggest that 9 percent of all equity funds are seriously misclassified and another 31 percent are somewhat misclassified. Two factors emerge as the most likely reasons for misclassification: (1) the ambiguity of the current classification system and (2) competitive pressures in the mutual fund industry and compensation structures that reward relative performance. Monte Carlo simulations on out-of-sample data show that this misclassification has a significant effect on investors' ability to build diversified portfolios of mutual funds.

Suggested Citation

  • Dan diBartolomeo & Erik Witkowski, 1997. "Mutual Fund Misclassification: Evidence Based on Style Analysis," Financial Analysts Journal, Taylor & Francis Journals, vol. 53(5), pages 32-43, September.
    • Handle: RePEc:taf:ufajxx:v:53:y:1997:i:5:p:32-43
    DOI: 10.2469/faj.v53.n5.2115
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