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Mutual/Hedge Funds

Do investors in mutual funds and hedge funds get their fair share of returns, or are they perpetually disadvantaged by fees and underperforming fund managers? Are there ways to exploit fund behaviors? These blog entries relate to mutual funds and hedge funds.

Mutual Fund Stock Selection vs. Market Timing

Can investors assess the performance of an active fund manager without access to the fund’s detailed trading records (especially trades not evident from quarterly holdings reports)? In the February 2009 update of his paper entitled “Active Alpha and Active Beta – Detecting the Unobserved Actions of Portfolio Managers”, Anders Ekholm presents a new methodology for indirectly measuring the effects of a fund manager’s trading that relies exclusively on portfolio returns. His approach decomposes fund tracking error into two aspects of active management: stock selection (idiosyncratic risk, or active alpha) and general market timing (systemic risk, or active beta). Applying this methodology to daily returns for a sample of actively managed U.S. equity mutual funds over the period 12/31/99-3/31/08, he finds that: Keep Reading

Morningstar Ratings and Future Returns

Does the Morningstar mutual fund rating system work? If so, how? In their March 2009 paper entitled “Selectivity, Market Timing and the Morningstar Star-Rating System”, Antonios Antypas, Guglielmo Caporale, Nikolaos Kourogenis and Nikitas Pittis investigate whether Morningstar mutual fund ratings enable investors to select funds that are likely to outperform in the future. Using data for 1,511 rated equity mutual funds since January 1998, they conclude that: Keep Reading

Actual Return Experience of Hedge Fund Investors

Do hedge fund investors actually receive the returns reported for hedge funds, or does the timing of investments in these funds substantially affect experienced returns? In the March 2009 version of their paper entitled “Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn”, Ilia Dichev and Gwen Yu measure actual hedge fund investor returns by integrating the returns of the funds they hold with the timing and magnitude of their capital flows into and out of these funds. Specifically, they calculate an aggregate internal rate of return (dollar-weighted return) that treats funds as time-ordered investor capital flows, with initial fund market value and fund inflows counted as negative flows and fund outflows and ending market value counted as positive flows. Using monthly net-of-fee return and assets under management data for a large sample of hedge funds over the period 1980-2006, they conclude that: Keep Reading

The Mutual Fund Research Newsletter Quarterly Asset Class Allocations

A reader requested: “Would you add Tom Madell’s Mutual Fund Research Newsletter to Guru Grades?” The most consistent thread in the Mutual Fund Research Newsletter archive for 2000-2008 [no longer publicly available] is the quarterly asset class allocation (stocks, bonds, cash) recommendation. Variation in recommended allocations across nine years supports a rough assessment of general market timing value. This assessment is related to, but more quantitative than, the narrative forecast reviews for other experts at Guru Grades. Because of this difference, we are not including Tom Madell in the list of experts at Guru Grades. Using the 36 Mutual Fund Research Newsletter quarterly asset class allocation recommendations, along with contemporaneous quarterly returns for proxy assets, we conclude that: Keep Reading

Hedge Fund Size Effect

Do small hedge funds tend to prosper in their chosen niches while large ones outgrow their opportunity sets? In his January 2009 paper entitled “Does Size Matter in the Hedge Fund Industry?”, Melvyn Teo examines the relationship between hedge fund size and future risk-adjusted (for seven factors) returns. Using monthly net-of-fee returns, assets managed and other characteristics for a large sample of live (3,177) and dead (4,240) hedge funds allocated to four styles over the period January 1994 through June 2008, he concludes that: Keep Reading

New Funds Outperform?

Do new mutual funds bring fresh alpha to the marketplace, outperforming until the market catches up and extinguishes it? In their August 2008 paper entitled “Performance and Characteristics of Mutual Fund Starts”, Aymen Karoui and Iwan Meier examine the performance and portfolio characteristics of U.S. equity mutual funds launched during 1991-2005. Using monthly return, quarterly holdings and fund characteristics/fee data for 1,374 U.S. domestic equity mutual funds and 828 fund starts over this period, they conclude that: Keep Reading

Hedge Fund Outperformance: Skill or Liquidity Risk?

Can outperforming hedge funds readily convert assets into cash for fund investors? In their October 2008 paper entitled “Hedge Fund Alphas: Do They Reflect Managerial Skills or Mere Compensation for Liquidity Risk Bearing?”, Rajna Gibson and Songtao Wang study the effect of market-wide liquidity risk (the time and costs of transforming a given position into cash and vice versa) on the performance of various hedge fund portfolio strategies. The strategies they consider are: Convertible Arbitrage, Dedicated Short Bias, Emerging Markets, Equity Market Neutral, Event-Driven, Fixed Income Arbitrage, Global Macro, Long/Short Equity Hedge, Managed Futures and Multi-Strategy. Using performance data for a broad sample of live (2,743) and defunct (1,955) hedge funds during 1994-2006 and contemporaneous measures of market-wide (U.S. equities) liquidity, they conclude that: Keep Reading

Sector Rotation vs. Stock Picking

Do expert investors outperform more by being in the right sectors (top-down economic analysis) or by picking the right stocks (bottom-up firm analysis)? In their November 2008 paper entitled “Impact of Sector Versus Security Choice on Equity Portfolios”, Jason Hall and Ben McVicar investigate the relative impact on equity mutual fund returns of industry sector allocation versus individual stock picks. They perform this investigation by constructing sector-neutral and stocks-within-sector-neutral benchmarks. Using data for 3,350 U.S. equity mutual funds over the period 1980-2005 (113,614 fund-quarter observations), they conclude that: Keep Reading

Exchange Traded Funds vs. Index Mutual Funds

Do Exchange Traded Funds (ETF) outperform comparable index mutual funds because of lower fees? In their November 2008 preliminary paper entitled “Exchange Traded Funds: Performance and Competition”, Marko Svetina and Sunil Wahal examine the performance of a very large number of ETFs over their entire histories relative both to their theoretical indexes and to matched index mutual funds. Using data for 584 domestic equity, international equity and fixed income ETFs and their indexes from their inception to the end of 2007, along with comparable data for matched index mutual funds, they conclude that: Keep Reading

Outperformance of Distinctive Hedge Fund Strategies?

Exceptional performance can stem from: (1) doing something others are doing, but doing it better; and (2) doing something different. Do hedge funds that have innovative strategies (do something different) systematically outperform? In their August 2008 paper entitled “Strategy Distinctiveness and Hedge Fund Performance”, Ashley Wang and Lu Zheng construct a “Hedge Fund Strategy Distinctiveness Index” (SDI) and test the predictive power of this index for future hedge fund returns. Specifically, they define SDI as [1 – R-squared] from a two-year regression of the returns for an individual hedge fund against the average returns of funds with the same investing style. This index represents the percentage of variation in a fund’s returns not explained by the variation of its peer’s returns. Using monthly return data for 2767 live and dead hedge funds over the period January 1994 through June 2007, they conclude that: Keep Reading

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