Mutual Funds

Companies | Industry News | Guides and Periodicals | Education
Do Past Winners Repeat? | The Magic Number

Mutual Fund Companies

• The Vanguard Group - The Low Cost Leader.
• Fidelity Investments - The Biggest Fund Company.
• Fund Search WSRN
• List of mutual funds from Qualistream
• Index Funds Online
• See also Money Managers

Industry News

• Mutual Fund Cafe is an excellent source of information about the mutual fund industry including weekly and monthly articles and reviews of the industry. Includes mergers and acquisitions and the Top 50 Fund Groups ranked by assets.
• AMG Data tracks flows of funds. RR
• NewsPage Major Mutual Funds news.
• Trim Tabs.com

Guides and Periodicals

• The vast majority of money invested in mutual funds goes into funds that have either four or five star ratings from Morningstar. While its difficult to gauge the exact degree of causation (or correlation) between Morningstar ratings and fund purchases, it is clear that Morningstar ratings have a major impact on investor behavior. As a result, Morningstar's rating system has come under a great deal of scrutiny. Wharton Professor Marshall Blume's article titled "An Anatomy of Morningstar Ratings" in the March/April issue of the Financial Analysts Journal argued that (1) funds with a long history are less likely to receive a five star rating than funds with a short history and that (2) no-load, diversified, domestic equity funds are far more likely to get four or five stars than they are to get one or two stars. More recently in the July/August edition of the FAJ, Stanford Professor William Sharpe's article titled "Morningstar's Risk-Adjusted Ratings" discussed drawbacks of Morningstar's system.
  
  Morningstar fully explains their system in "Star Ratings" and further perspective can be found in articles by John Rekenthaler (Morningstar's Research Director) - response to Blume's article (7/2/98) and response to Sharpe's article (9/4/98). To Morningstar's credit they have run several articles pointing out that hot fund categories tend to underperform unpopular categories. For instance, see Buy the unloved and Unpopularity Contest. See also DO take a skeptical attitude toward mutual fund ratings on the Bloomberg site. And what many investors really want to know is how do top rated funds perform going forward. According to Mark Hulbert, the Hulbert Financial Digest has been tracking Morningstar’s performance since the beginning of 1991. Over the subsequent nearly seven years, Morningstar’s top-ranked no-load equity funds have lagged the stock market by an average of nearly three percentage points per year. " See Hulbert's "No Stars for Morningstar" in Forbes (12/29/97).
• InvestorSquare - Screen, rank and profile 9500 mutual funds.
• Mutual Funds Interactive (Brill)
• Mutual Funds Magazine RR
• IBC Data formerly IBC/Donoghue has tables including highest yielding money and bond funds.
• The EDGAR Mutual Funds database
• Mutual Fund Cost Calculator from the SEC
• Fund Alarm focuses on Mutual Funds that you might want to consider selling because of manager changes (and other reasons).

Education - See also Benchmarks and Performance Evaluation

• The Vanguard Group's
  • An Introduction to Mutual Funds
  • Reading a Mutual Fund Prospectus
  • Reading an Annual or Semiannual Report
  • Taxes and Mutual Funds
  • Nothing Fails Like Sucess by John Bogle
• An introduction to Mutual Funds from the SEC.
• Frequently asked questions about mutual funds from Fundmaster.
• All about money funds from IBC Data.
• Stanford Professor and Nobel Prize winner William F. Sharpe has posted The Styles and Performance of Large Seasoned Mutual Funds, 1985-1994. It is not written for the novice but makes for interesting reading from one of the best known educators and writers in the industry. You can also read an interview with Professor Sharpe titled Setting the Record Straight on Style Analysis.
• This is an abstract (Of Tournaments and Temptation) of an interesting Journal of Finance article that discusses mutual fund fees and how fund managers act depending on their performance.
• The Vanguard Groups's TIC-TAC-TOE: Style Analysis and Mutual Fund Performance by John C. Bogle was the Keynote Speech at the June Morningstar Conference. The article offers evidence that fund expenses are an indicator of future performance.
• The July/August 1997 issue of Bloomberg Personal included an article titled "Cheaper is Better" by Jonathon Burton. The following are a few excerpts from the article
  • "Fund expenses make a difference-a huge difference-in your bottom-line investment return. In fact, according to a new study by Bloomberg Personal, low-cost funds are much more likely to deliver above-average performance than high-cost ones..."
  • "Phillips [Morningstar] has also produced disturbing research showing that higher-expense bond funds often take greater risks."
• Getting wise to mutual fund fees from Fortune (12/23/96).
• A feature on high fund fees from Money.
• 20 question about mutual funds from the Investment Company Institute
• What do individual investors consider when buying a fund? According to an Investment Company Institute study 75% considered performance, 69% Risk, 49% Investment Goals, 46% Portfolio securities, and only 43% considered fees and expenses. Empirical studies suggest performance should certainly not be the primary consideration, but fees and expenses arguably should be.

Do Past Winners Repeat?

An important issue that has been the subject of intense debate in recent years is the question of whether mutual fund managers and funds that have performed well in the past will continue to outperform in the future. Mutual fund tracking services, periodicals, and web sites (see above) regularly publish top performing funds on a continuing basis. However, if past performance does not predict future performance, this information is of little use in selecting mutual funds going forward. While there have been studies showing that strong performers continue to outperform over certain periods, several recent studies have demonstrated that investors should not expect recent strong performers to outperform in the future. This article by Ronald N. Kahn and Andrew Rudd of BARRA titled "Does Historical Performance Predict Future Performance?" is an example supporting the argument against persistent performance. The study includes references to previous studies that did and studies that did not find support for persistence. Although they did find some evidence of persistence in fixed income funds, the authors come to the conclusion that both equity and fixed income investors may be better served by investing in index funds as opposed to funds that have performed well in the past.

Another recent study by Burton G. Malkiel (author of A Random Walk Down Wall Street ) in the June 1995 edition of Journal of Finance titled "Returns from Investing in Equity Mutual Funds 1971 to 1991" also addressed the issue. You can read the Abstract here. Numerous studies had demonstrated persistence in performance in the 1970s and Malkiel confirmed these findings. Malkiel specifically examined the issue of survivorship bias - the fact that poor performing mutual funds tend to disappear (commonly by merging into more successful funds "thereby burying the fund's bad record with it." See also Cherry-Picking). Approximately 3% of mutual funds disappear every year. The result is that most long term performance records do not include the records of poor performing funds that no longer exist. By examining all mutual funds that existed at the time, Malkiel determined "that survivorship bias is considerable more important than previous studies have suggested." Malkiel admits that the analysis provided some support for the buying funds with excellent records since they outperformed during certain periods and do no worse than the average fund, however he presented three caveats. First, the results are not robust, second, the returns are not actually achievable because of load charges and third, survivorship bias has to be accounted for. He concluded that

• "It does not appear that one can fashion a dependable strategy of generating excess returns based on a belief that long-run mutual fund returns are persistent."
• "... funds have underperformed benchmark portfolios both after management fees and even gross of expenses."
• "... while considerable performance persistence existed during the 1970s, there was no consistency in fund returns during the 1980s."
• "... we have been unable to fashion a dependable strategy by which an investor can consistently achieve excess returns over long periods of time."
• "Most investors would be considerably better off by purchasing a low expense index fund, than by trying to select an active fund manager who appears to possess a "hot hand."

Malkiel also discussed Forbes Magazine "honor roll" which ranks mutual funds for performance in both up and down markets. Over the 16-year period from 1975 to 1991, the "honor role" underperformed the S&P 500. Further, the results ignored load charges which would have reduced performance.

Malkiel also analyzed mutual fund fees to determine whether higher fees resulted in better performance. The study found "essentially no relationship between gross investment returns and expenses." Malkiel concluded that "The data do not give one much confidence that investors get their money's worth from investment advisory expenditures."

Mark M. Carhart of the University of Southern California has done extensive research on survivorship bias and authored a recent article titled "On Persistence in Mutual Fund Performance" in the March 1997 issue of the Journal of Finance (Here is the abstract). Carhart concluded that "The results do not support the existence of skilled or informed mutual fund portfolio managers." You can read more about the Carhart article in Jason Zweig's commentary in Money and in Journal Watch RR from Asset Management (Jan 97).

Other articles on the subject include The Grand Infatuation (7/99) by William Bernstein, several from The Vanguard Group (The Perils of Relying on Past Performance and Pursuing Past Performance Is A Common, Costly Error), Past Performance from Errold Moody, an article in the Washington Post by James Glassman on the dangers of investing in top performing funds, and Performance Persistence (Abstract) by Stephen J. Brown and William N. Goetzmann in the Journal of Finance (June 96).

In a study that may come as a surprise to proponents of hedge funds, Professors Stephen J. Brown, William N. Goetzmann, and Roger G. Ibbotson (in their study Offshore Hedge Funds: Survival & Performance 1989 - 1995 in Adobe Acrobat format) found "no evidence of performance persistence in raw returns or risk-adjusted returns, even when we break funds down according to their returns-based style classification." They conclude that "the hedge fund arena provides no evidence that past performance forecasts future performance." It's important to note however, that this study covers a relatively short time period and that determining accurate and comparable performance figures in the hedge fund arena is extremely complex.

In the March/April issue of Bloomberg Personal, Roger G. Ibbotson claimed that "styles of mutual funds typically explain more than 90 percent of the variations in returns." Ibbotson argued that when comparing returns of funds to their benchmarks (as opposed to broad based benchmarks), winners do tend to persist. Ibbotson believes that it is not possible to forecast which styles will do the best, but predicting the best funds within an investment style is possible. However, Ajay Khorana and Edward Nelling recently found little evidence of performance persistence by sector-fund managers relative to both their peer group and the S&P 500 ("The Performance, Risk, and Diversification of Sector Funds," Financial Analysts Journal, May/June 1997).

Selected Quotes on Mutual Funds

"Todays hero is often tomorrows blockhead."
Peter L. Bernstein, Against the Gods

"There is some evidence that last year's winners tend to repeat next year. But it is very slight. Mostly the effect comes from the fact that really bad funds stay bad. Their expenses are high, and their choices stay haphazard."

Paul A. Samuelson, "The Long-Term Case for Equities," The Journal of Portfolio Management, Fall 1994.

How quickly investors flock to better-performing mutual funds, even though financial researchers have shown that the "hot" funds in one time period very often turn out to be the poorest performers in another.
David Dreman, The New Contrarian Investment Strategy

"If you pay the executives at Sarah Lee more, it doesn't make the cheesecake less good. But with mutual funds, it comes directly out of the batter."

Don Phillips (Morningstar President) in U.S. News & World Report article on July 8, 1996 commenting on whether paying higher fees for mutual funds results in higher returns.

"Past performance is no indicator of future results. Fund historical performance does not promise the same results in the future."
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Last update 8/9/99. Copyright © 1999 Investor Home. All rights reserved. Disclaimer