Good and Bad High-fee Mutual Funds
April 11, 2017 - Mutual/Hedge Funds
Should investors shun mutual funds with high fees? In their February 2017 paper entitled “Cheaper is Not Better: On the Superior Performance of High-Fee Mutual Funds”, Jinfei Sheng, Mikhail Simutin and Terry Zhang re-examine the conventionally accepted negative relationship between expense ratio and future net performance of actively managed equity mutual funds. They measure fund performance as alpha from each of four factor models of stock returns:
- 1-factor: the Capital Asset Pricing Model, which controls for the market factor.
- 3-factor: the widely used Fama-French model, which controls for market, size and value (book-to-market ratio) factors.
- 4-factor: the widely used Carhart model, which adds the momentum factor to the 3-factor model.
- 5-factor: the recent Fama-French model that adds profitability and investment factors to the 3-factor model.
They calculate alpha for each fund each month as the difference between next-month excess return minus expected return based on fund factor loadings from a regression over the last 60 months. They then use additional regressions and a ranking of funds into tenths (deciles) by fee to analyze relationships between alphas and fees. Using survivorship bias-free performance, sales channel and holding data for active U.S. domestic equity funds with at least five years of history and substantial holdings/assets during 1980 through 2014, they find that: Keep Reading