Week 9 Flashcards
(32 cards)
What are the two main types of tests in mutual fund performance?
Evidence of abnormal performance (test for skill), and evidence of performance persistence.
Why is it important to consider fees when assessing fund performance?
Because fees significantly impact net returns and the value added for investors.
What are gross returns vs net returns?
Gross returns are before fees; net returns are after deducting fees.
When should we use gross returns?
To assess whether fund managers have skill.
When should we use net returns?
To assess whether managers add value for investors.
Why aren’t front-end/back-end loads deducted when calculating net returns?
Because they approximate transaction costs, keeping comparisons with direct investment consistent.
What is survivorship bias in mutual fund performance data?
The bias from excluding dead (closed) funds, which tend to be poor performers.
Why is survivorship bias a problem?
It leads to overestimation of average mutual fund performance.
How can survivorship bias be addressed?
By including data on both surviving and dead funds in analysis.
What is a common performance measure in mutual fund literature?
Alpha, especially from multi-factor models like the Fama-French 3-factor.
Why are alphas preferred over Sharpe ratios in fund studies?
They better reflect value added given a fund’s risk exposures.
What is the Fama-French 3-factor model?
A model that adjusts returns for market, size, and value risk factors.
What is the Carhart 4-factor model?
A model that adds momentum to the Fama-French 3-factor model.
What do Fama and French find about mutual fund performance?
Net-of-fee alphas are around zero; managers on average just earn back their fees.
What does this imply about active fund managers?
They do not add significant value on average.
What does zero abnormal performance imply about managers?
It could mean performance is random or the average of skilled and poor managers cancels out.
What does Carhart (1997) say about persistence?
A small group of managers may consistently outperform or underperform.
What method do Fama and French use to test for persistence?
Sorting funds into deciles based on t-stats of 60-month returns or alphas.
What do alpha-based sorts show?
Some evidence of persistence, but weak and not consistent over time.
What is the overall conclusion on performance persistence?
Weak and inconsistent evidence; not robust over time.
What is the smart money effect?
The idea that investors can identify skilled managers before they outperform.
How is the smart money effect tested?
By relating net fund flows to future risk-adjusted performance.
What did Gruber find about smart money?
Positive net flow funds outperform; a combined long-short strategy based on fund flows yields 14.7 basis points per month.
What limitation did Gruber’s study have?
He did not test for statistical significance.
