Mutual Fund Performance and Manager Style

In this analysis of the relationship between equity mutual fund performance and manager style, two questions are addressed. First, does any investment style generate abnormal returns on average? Second, when funds are grouped by equity style, does any style exhibit performance persistence? The answers from this study are as follows: None of the styles earned positive abnormal returns during the 1965–98 sample period, and value funds realized negative abnormal returns of about 2.75 percentage points a year. Some evidence was found of short-run performance persistence among the best-performing growth funds and among the worst-performing small-cap funds. In this examination of the relationship between mutual fund performance and the investment style of the fund manager, I address two specific issues. First, does any equity investment style reliably deliver abnormal performance? Second, when funds with similar styles are compared, does any style exhibit performance persistence? The equity styles investigated in this study were classified along two general dimensions—value versus growth and small capitalization versus large capitalization.Data for the study came primarily from the Center for Research in Security Prices (CRSP) database of U.S. mutual funds for 1962 through 1998. This database is essentially free of the survivorship bias that plagues most studies of mutual fund performance. The sample constructed from this database contained nearly 4,700 domestic equity mutual funds.The benchmark against which mutual fund performance was measured was the three-factor model of Fama and French. I chose this model as the performance benchmark for two reasons. First, prior research has shown that the three factors in the model have explanatory power for stock returns because they are associated with risk. If the factors do measure risk, then the average returns of fund managers should be large enough to compensate for these risk factors. Second, passive buy-and-hold portfolios can be formed that allow investors to earn the premiums associated with the three factors of the Fama-French model. So, if active fund management has economic value, active managers should outperform such a passive strategy.None of the styles in the study generated positive abnormal returns relative to the Fama-French benchmark. Value funds generated negative abnormal returns during the sample period of about 2.7 percentage points a year. I found some evidence of performance persistence, but the abnormal performance tended to die out quickly. The best-performing growth managers tended to continue to perform well during the year after they were identified as good performers, and the worst-performing small-cap managers continued to generate negative abnormal returns after they were identified as poor performers.These results are not good news for investors who purchase actively managed mutual funds. The average fund, regardless of style, does not reliably outperform a passive benchmark that has similar style characteristics. Even the best-performing funds do not maintain superior performance for extended periods of time. Based on the performance of U.S. equity funds during the past three decades, a reliable payoff to active fund management was not realized.