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Abstract:
Financial theory is often based on the belief that the actions of rational investors determine prices, which leads to the elimination of dominated financial instruments. Recently a series of articles have been published which question the rationality of investor behavior. Standard and Poor s 500 index funds represent one of the simplest vehicles for examining whether investors make rational decisions consistent with the normal paradigm of financial economics. S&P 500 index funds hold virtually the same securities, yet they differ by more than two percent per year in the fees they charge investors and the returns they offer investors. In this paper, we show that the relative returns offered by alternative S&P index funds are easily predictable. We show that the other important aspects of performance, risk and tax efficiency, are also easily predictable. Despite this predictability, the relationship between new cash flows and performance is much weaker than we would expect based on rational behavior. Marketing and spillover account for some, but only a small amount, of the cash flows not accounted for by performance. We show that selecting funds based on low expenses or high past returns leads to a portfolio that outperforms the portfolio of index funds selected by investors. Our results exemplify the fact that, in a market where arbitrage is not possible, dominated products can prosper.

Abstract:
Financial theory is often based on the belief that the actions of rational investorsdetermine prices, which leads to the elimination of dominated financial instruments. Recently a series of articles have been published which question therationality of investor behavior. Standard and Poor s 500 index funds represent one of the simplest vehicles for examining whether investors make rational decisions consistent with the normal paradigm of financial economics. S&P 500 index funds hold virtually the same securities, yet they differ by more than two percent per year in the fees they charge investors and the returns they offerinvestors. In this paper, we show that the relative returns offered by alternativeS&P index funds are easily predictable. We show that the other important aspects of performance, risk and tax efficiency, are also easily predictable. Despite this predictability, the relationship between new cash flows and performance is much weaker than we would expect based on rational behavior. Marketing and spillover account for some, but only a small amount, of the cash flows not accounted for by performance. We show that selecting funds based on low expenses or high past returns leads to a portfolio that outperforms the portfolio of index funds selected by investors. Our results exemplify the fact that, in a market where arbitrage is not possible, dominated products can prosper.

Abstract:
Financial theory is often based on the belief that the actions of rational investors determine prices, which leads to the elimination of dominated financial instruments. Recently a series of articles have been published which question the rationality of investor behavior. Standard and Poor's 500 index funds represent one of the simplest vehicles for examining whether investors make rational decisions consistent with the normal paradigm of financial economics. S&P 500 index funds hold virtually the same securities, yet they differ by more than two percent per year in the fees they charge investors and the returns they offer investors. In this paper, we show that the relative returns offered by alternative S&P index funds are easily predictable. We show that the other important aspects of performance, risk and tax efficiency, are also easily predictable. Despite this predictability, the relationship between new cash flows and performance is much weaker than we would expect based on rational behavior. Marketing and spillover account for some, but only a small amount, of the cash flows not accounted for by performance. We show that selecting funds based on low expenses or high past returns leads to a portfolio that outperforms the portfolio of index funds selected by investors. Our results exemplify the fact that, in a market where arbitrage is not possible, dominated products can prosper.

rationality, index funds, mutual funds

Abstract:
The valuation of corporate debt is an important issue in asset pricing. While there has been an enormous amount of theoretical modeling of corporate bond prices, there has been relatively little empirical testing of these models. Recently there has been extensive development of rating based models as a type of reduced form model. These models take as a premise that groups of bonds can be identified which are homogeneous with respect to risk. For each risk group the models require estimates of several characteristics such as the spot yield curve, the default probabilities and the recovery rate. These estimates are then used to compute the theoretical price for each bond in the group. The purpose of this article is to clarify some of the differences among these models, to examine how well they explain prices, and to examine how to group bonds to most effectively estimate prices.

debt, valuation

Abstract:
The purpose of this article is to examine the impact of incentive fees on mutual fund performance. The paper proceeds as follows. In the first section we examine the characteristics and the use of incentive fees in the mutual fund industry. In the second section we explore the theory of the effect of incentive fees on manager behavior. In the third section we discuss our data. In the fourth section we examine empirical results concerning fees earned, risk-adjusted performance, the effect of incentive fees on risk, and new cash flows into funds using incentive fees.

Abstract:
The purpose of this article is to examine the impact of incentive fees on mutual fund performance. The paper proceeds as follows. In the first section we examine the characteristics and the use of incentive fees in the mutual fund industry. In the second section we explore the theory of the effect of incentive fees on manager behavior. In the third section we discuss our data. In the fourth section we examine empirical results concerning fees earned, risk-adjusted performance, the effect of incentive fees on risk, and new cash flows into funds using incentive fees.

Abstract:
This paper examines the effect of incentive fees on the behavior of mutual fund managers. Funds with incentive fees exhibit positive stock selection ability, but a beta less than one results in funds not earning positive fees. From an investor's perspective, positive alphas plus lower expense ratios make incentive-fee funds attractive. However, incentive-fee funds take on more risk than non-incentive-fee funds, and they increase risk after a period of poor performance. Incentive fees are useful marketing tools, since more new cash flows go into incentive-fee funds than into non-incentive-fee funds, ceteris paribus.

Abstract:
The impact of incentive fees on management performance has become an increasingly important subject in the literature of financial economics. Yet, despite a large number of theoretical articles on the impact of incentive fees, there has been almost no empirical testing of the theories. In this article we use a carefully constructed sample of mutual funds to study the impact of incentive fees. Mutual funds are a particularly interesting vehicle for studying incentive fees, for funds exist that have incentive fees and funds exist that do not have incentive fees. In addition, the data provided by mutual funds are sufficiently detailed to allow correction for survivorship bias. We find that while many of the theoretical implications of the literature on incentive fees are borne out, some are not. We find that funds with incentive fees have not, on average, been able to earn positive incentive fees. This suggests that managers on average haven't been able to outperform their benchmarks or to design benchmarks which work to their advantage. However, funds with incentive fees have an average risk-adjusted performance of about zero, which is higher than most studies have found for funds without incentive fees. This suggests that funds with incentive fees have at least some tendency to attract superior managers and/or to obtain more effort from managers in place. While there seems to be a modest impact of incentive fees on average returns, there clearly is a larger impact on risk taking. Funds with incentive fees have higher risk than funds without incentive fees. Whether risk taking is measured in terms of tracking error or total risk, incentive fees cause risk taking. In addition, as theories suggest, funds that underperform their benchmarks in the first part of an evaluation period increase risk in the second part, while funds that are overperforming relative to the index tend to reduce risk. Managers using incentive fees often pursue non-benchmark strategies in an attempt to earn excess returns and higher fees. For example, many funds with the S&P 500 as their benchmark have significant exposure to small stocks. Surprisingly, funds on average have a beta less than one when a beta greater than one would have provided a higher expected return with potentially the same tracking error. There are two types of managers subject to incentive fees: internal managers and external managers. Internal managers play a larger role in setting the incentive benchmarks, while outside managers are more at risk of being replaced. Inside managers do better relative to the benchmark than outside managers, and they also take greater risk in terms of total risk and deviations from the benchmark. Finally, we find that funds that have incentive fees attract more capital ceteris paribus than funds in general. This is an added reason why managers might choose to use an incentive fee.

Abstract:
Many financial institutions employ outside portfolio managers to manage part or all of their inevitable assets. The purpose of this article is to set up a structure that leads to the optimum portfolio from the viewpoint of the centralized decision maker when there are multiple managers and their portfolios are constructed without reference to each other.

Abstract:
Since Elton and Gruber's (E&G) original article on taxes and ex-dividend price behavior was published in 1970, over 100 articles have appeared in the leading journals of financial economics examining whether prices fall by less than the dividends and, if so, whether or not the phenomenon is due to tax effects, market microstructure effects, or some other effect. The microstructure argument is the most serious alternative to the tax argument.

All of the microstructure arguments state that the fall in stock price should be less than the dividend, regardless of whether the dividend is taxable or tax-advantaged. By testing ex-dividend effects on a sample of closed-end funds where dividends are taxadvantaged, we find that taxes should and do cause the fund price to fall by more than the amount of the dividend. This is consistent with a tax argument and inconsistent with a microstructure argument. Examining the sample of tax-free dividends, we find that the E&G and return measures change across two tax regimes exactly as theory suggests they should if taxes mattered.

We then examine non-tax-advantaged closed-end funds. For these funds we should find the traditional ex-dividend tax effects: the fall in price on the ex-dividend date should be less than the dividend during periods when capital gains taxes are less than income taxes. This is what we find. Furthermore, the ex-dividend behavior of these funds generally moves in the direction we would expect across two changes in tax regimes. The taxable sample not only substantiates the tax effect, it also demonstrates that the fall in price greater than the dividend for closed-end municipal bond funds was not due to some peculiar aspect of either our methodology or the closed-end fund industry.

Thirty-two years after E&G's original study, we find new and compelling evidence that taxes play an important part in affecting share price changes.

Abstract:
One of the clearest trends in asset management is the rapid increase in the amount of individual and institutional money invested in indexed products. By far the most popular index that investors want to replicate is the S&P 500 index. While many academic studies have examined the characteristics of two instruments frequently used to replicate the S&P, index funds and futures, very little has been written about the newest way to replicate the S&P 500 index: Standard and Poors Depository Receipts (SDPR) commonly referred to as Spiders. The purpose of this paper is to analyze Spiders and compare them to alternative investments.

spiders, index funds, mutual funds, performance

Abstract:
One of the clearest trends in asset management is the rapid increase in the amount of individual and institutional money invested in indexed products. By far the most popular index that investors want to replicate is the S&P 500 index. While many academic studies have examined the characteristics of two instruments frequently used to replicate the S&P, index funds and futures, very little has been written about the newest way to replicate the S&P 500 index: Standard and Poors Depository Receipts (SDPR) commonly referred to as Spiders. The purpose of this paper is to analyze Spiders and compare them to alternative investments.

spiders, index funds, mutual funds, performance

Abstract:
Defined-contribution plans represent a major organizational form for investors' retirement savings. Today more than one third of all workers are enrolled in 401K plans. In a 401K plan, participants select assets from a set of choices designated by an employer. For over half of 401K-plan participants, retirement savings represent their sole financial asset. Yet to date there has been no study of the adequacy of the choices offered by 401K plans. This paper analyzes the adequacy and characteristics of the choices offered to 401K-plan participants for over 400 plans. We find that, for 62% of the plans, the types of choices offered are inadequate, and that over a 20-year period this makes a difference in terminal wealth of over 300%. We find that funds included in the plans are riskier than the general population of funds in the same categories. We study the characteristics of plans that are associated with adequate investment choices, including an analysis of the use of company stock, plan size, and the use of outside consultants. When we examine one category of investment choices, S&P 500 index funds, we find that the index funds chosen by 401K-plan administrators are on average inferior to the S&P 500 index funds selected by the aggregate of all investors.

Abstract:
To implement mean variance analysis one needs a technique for forecasting correlationcoefficients. In this article we investigate the ability of several techniques to forecast correlation coefficients between securities. We find that separately forecasting the average level of pairwise correlations and individual pair-wise differences from the average improves forecasting accuracy. Furthermore, forming homogenous groups of firms on the basis of industry membership or firm attributes (eg. Size) improves forecast accuracy. Accuracy is evaluated in two ways: First, in terms of the error in estimating future correlation coefficients. Second, in the characteristics of portfolios formed on the basis of each forecasting technique. The ranking of forecasting techniques is robust across both methods of evaluation and the better techniques outperform prior suggestions in the literature of financialeconomics.

Abstract:
To implement mean variance analysis one needs a technique for forecasting correlation coefficients. In this article we investigate the ability of several techniques to forecast correlation coefficients between securities. We find that separately forecasting the average level of pair-wise correlations and individual pair-wise differences from the average improves forecasting accuracy. Furthermore, forming homogenous groups of firms on the basis of industry membership or firm attributes (eg. Size) improves forecast accuracy.

Accuracy is evaluated in two ways: First, in terms of the error in estimating future correlation coefficients. Second, in the characteristics of portfolios formed on the basis of each forecasting technique. The ranking of forecasting techniques is robust across both methods of evaluation and the better techniques outperform prior suggestions in the literature of financial economics.

Correlation, forecasting, portfolio analysis, portfolio inputs

Abstract:
In this paper we show that selecting mutual funds using alpha computed from a fund’s holdings and security betas produces better future alphas than selecting funds using alpha computed from a time series regression on fund returns. This is true whether future alphas are computed using holdings and security betas or a time series regression on fund returns. Furthermore, we show that the more frequently the holdings data are available, the greater the benefit. This has major implications for the SEC’s recent ruling on the frequency of holdings disclosure and the information plan sponsors should collect from portfolio managers. We also explore the effect of conditioning betas on macro variables as suggested by Ferson and Schadt (1996) to identify superior-performing mutual funds as well as the alternative way of employing holdings data proposed by Grinblatt and Titman (1993).

mutual funds, portfolios, composition, performance prediction

Abstract:
Many investors confine their mutual fund holdings to a single fund family, either for simplicity or through restrictions placed by their retirement savings plan. We find evidence that mutual fund returns are more closely correlated within than between fund families. As a result, restricting investment to one fund family leads to a greater total portfolio risk than diversifying across fund families. The increased correlation is due primarily to common stock holdings, but is also more generally related to families having similar exposures to economic sectors or industries. Fund families also show a propensity to focus on high risk or low risk strategies, which leads to a greater dispersion of risk across restricted investors. An investor considering adding an additional fund either inside or outside the family would need to believe the inside fund offered an additional 50 to 70 basis points in return to achieve the same Sharpe ratio.

Abstract:
A number of articles in financial economics have used quarterly or semi-annual mutual fund holdings data to test hypotheses about investment manager behavior. This article reexamines four well-known hypotheses in finance to determine whether the results of prior tests of these hypotheses remain valid when higher frequency (monthly) holdings data are employed. The areas examined are: momentum trading, tax-motivated trading, window dressing, and tournament behavior. We find that the use of monthly holdings data rather than quarterly holdings data or, in the case of tournament behavior, holdings data rather than monthly return data, change, and in some cases reverse, previous results. This occurs because monthly holdings data capture a large number of trades missed by quarterly data (18.5% of the trades) and permit a more precise estimation of the timing of trades.

mutual funds, holdings, momentum, tournament, window dressing, tax effects

Abstract:
The CRSP database is a fairly new publicly available database on mutual funds. It is comprehensive and is corrected for survivorship bias. It and the Morningstar database are likely to be the standard databases used by researchers in the future. Despite the care that has been exercised in compiling the CRSP database, it needs to be corrected for certain types of problems. The most obvious bias in the CRSP database is that it calculates fund returns for months with multiple distributions on the same day in a way that causes returns in those months to be overstated. This overstatement has an impact on overall returns and alphas which is of economic significance. The Morningstar database is free of this problem.

We have shown that while CRSP does not suffer from survivorship bias, it does suffer from omission bias. Because only some small funds under $15 million in total net assets have monthly data on the CRSP database, and because the omitted funds have much greater merge and liquidation rates, we show that the returns reported for that group of funds which have monthly data overstate the population returns and alphas. We then examine the data CRSP provides on mergers. While these data are quite good in identifying mergers, we show that there are major problems in merger dates and reporting return data up to the time of the merger.

mutual funds, CRSP, moringstar, mutual funds

Abstract:
The CRSP database is a fairly new publicly available database on mutual funds. It is comprehensive and is corrected for survivorship bias. It and the Morningstar database are likely to be the standard databases used by researchers in the future. Despite the care that has been exercised in compiling the CRSP database, it needs to be corrected for certain types of problems. The most obvious bias in the CRSP database is that it calculates fund returns for months with multiple distributions on the same day in a way that causes returns in those months to be overstated. This overstatement has an impact on overall returns and alphas which is of economic significance. The Morningstar database is free of this problem.

We have shown that while CRSP does not suffer from survivorship bias, it does suffer from omission bias. Because only some small funds under $15 million in total net assets have monthly data on the CRSP database, and because the omitted funds have much greater merge and liquidation rates, we show that the returns reported for that group of funds which have monthly data overstate the population returns and alphas. We then examine the data CRSP provides on mergers. While these data are quite good in identifying mergers, we show that there are major problems in merger dates and reporting return data up to the time of the merger.

mutual funds, CRSP, moringstar, mutual funds

Abstract:
Portfolio theory is a well-developed paradigm. There are excellent textbooks on the subject. Of course, we are especially partial to our own Modern Portfolio Theory and Investment Analysis. There are also good reviews in more advanced doctoral-level texts such as Ingersoll (1987) or Huang and Litzenberger (1988). Finally, good review articles such as Constantinedes and Malliaris (1995) exist. Therefore, instead of writing one more review article, we will be more selective and our discussion will be rather eclectic. This paper will present four topics we find of particular interest. Rather than attempting to survey all articles or all issues on each topic, we will discuss what we find of special interest and importance. We will attempt to convey wehere the field is today and where it is headed in the future.

Abstract:
Portfolio theory is a well-developed paradigm. There are excellent textbooks on the subject. Of course, we are especially partial to our own Modern Portfolio Theory and Investment Analysis. There are also good reviews in more advanced doctoral-level texts such as Ingersoll (1987) or Huang and Litzenberger (1988). Finally, good review articles such as Constantinedes and Malliaris (1995) exist. Therefore, instead of writing one more review article, we will be more selective and our discussion will be rather eclectic. This paper will present four topics we find of particular interest. Rather than attempting to survey all articles or all issues on each topic, we will discuss what we find of special interest and importance. We will attempt to convey wehere the field is today and where it is headed in the future.

Abstract:
This is the first study to examine both how well plan administrators select funds and howparticipants react to plan administrator decisions. We find that on average administrators select funds that outperform randomly selected funds of the same type. When administrators change offerings, they choose funds that did well in the past, but after the change deleted funds do better than added funds. Plan participants react strongly to past performance in their allocation decisions. This accentuates the changes in allocation caused by returns. Participant allocations do no better than naïve allocation rules such as equal investment in each offering.

Abstract:
This is the first study to examine both how well plan administrators select funds for 401(k) plans and how participants react to plan administrator decisions. We find that, on average, administrators select funds that outperform randomly selected funds of the same type. When administrators change offerings, they choose funds that did well in the past, but, after the change, added funds do no better than dropped funds. Plan participants change their allocation decisions in a way that accentuates the changes in allocation caused by returns. The change in participant weights due to the allocation of new money and interfund transfers is about the same size, and in the same direction, as the change due to returns. Participant allocations do no better than naïve allocation rules, such as equal investment in each offering.

pension plans, 401(k), defined-contribution plans, mutual fund performance

Abstract:
In this paper we use data on the monthly holdings for a set of mutual funds to study the timing ability of these funds. By examining monthly holdings we are able to see how management changes the risk parameters and industry holdings in a fund and to examine how this contributes to timing. We find evidence that timing decisions result in a decrease in performance, whether timing is measured using conditional or unconditional sensitivities. Likewise, sector rotation decisions also result in lower returns. Examining the results for individual sectors shows that the majority of the negative impact on returns from sector rotation comes about because of a fund changing exposure to high-tech stocks.

mutual funds, portfolios, composition, timing

Abstract:
The purpose of this article is to explain the spread between spot rates on corporate and government bonds. We find that the spread can be explained in terms of three elements: (1) compensation for expected default of corporate bonds (2) compensation for state taxes since holders of corporate bonds pay state taxes while holders of government bonds do not, and (3) compensation for the additional systematic risk in corporate bond returns relative to government bond returns. The systematic nature of corporate bond return is shown by relating that part of the spread which is not due to expected default or taxes to a set of variables which have been shown to effect risk premiums in stock markets Empirical estimates of the size of each of these three components are provided in the paper. We stress the tax effects because it has been ignored in all previous studies of corporate bonds.

Abstract:
The valuation of corporate debt is an important issue in asset pricing. While there has been an enormous amount of theoretical modeling of corporate bond prices, there has been relatively little empirical testing of these models. Recently there has been extensive development of rating based reduced form models. These models take as a premise that bonds when grouped by ratings are homogeneous with respect to risk. For each risk group the models require estimates of several characteristics such as the spot yield curve, the default probabilities and the recovery rate. These estimates are then used to compute the theoretical price for each bond in the group. The purpose of this article is to examine the pricing of corporate bonds when bonds are grouped by ratings, and to investigate the ability of characteristics, in addition to bond ratings, to improve the performance of rating based models. Most of our testing will be conducted in models which are in the spirit of the theory developed by Duffie and Singleton (1997) and Duffie (1999).The paper is divided into three sections. In the first section, we discuss various reduced form models that have been suggested in the literature. In the second section we examine how well standard classifications serve as a metric for forming homogeneous groups. In this section we show that using standard classifications results in errors being systematically related to specific bond characteristics. Finally, in the last section we take account of these specific bond characteristics in our estimation procedure for determining spot prices and show how this lead to improved estimates of corporate bond prices.

Abstract:
The valuation of corporate debt is an important issue in asset pricing. While there has been an enormous amount of theoretical modeling of corporate bond prices, there has been relatively little empirical testing of these models 1 . Recently there has been extensive development of rating based reduced form models. These models take as a premise that bonds when grouped by ratings are homogeneous with respect to risk. For each risk group the models require estimates of several characteristics such as the spot yield curve, the default probabilities and the recovery rate. These estimates are then used to compute the theoretical price for each bond in the group. The purpose of this article is to examine the pricing of corporate bonds when bonds are grouped by ratings, and to investigate the ability of characteristics, in addition to bond ratings, to improve the performance of rating based models. Most of our testing will be conducted in models which are in the spirit of the theory developed by Duffie and Singleton (1997) and Duffie (1999).

Abstract:
There is overwhelming evidence that, post expenses, mutual fund managers on average underperform a combination of passive portfolios of similar risk. The recent increase in the number and types of index funds that are available to individual investors makes this a matter of practical as well as theoretical significance. Numerous index funds, which track the S&P 500 index or various small-stock, bond, value, growth, or international indexes, are now widely available to individual investors. These same choices have been available to institutional investors for some time. Given that there are sufficient index funds to span most investors risk choices, that the index funds are available at low cost, and that the low cost of index funds means that a combination of index funds is likely to outperform an active fund of similar risk, the question is, why select an actively managed fund?

Abstract:
We examine predictability for stock mutual funds using risk- adjusted returns. We find that past performance is predictive of future risk-adjusted performance. Applying modern portfolio theory techniques to past data improves selection and allows us to construct a portfolio of funds that significantly outperforms a rule based on past rank alone. In addition, we can form a combination of actively managed portfolios with the same risk as a portfolio of index funds but with higher mean return. The portfolios of funds selected have small but statistically significant positive risk-adjusted returns during a period where mutual funds in general had negative risk-adjusted returns.

Abstract:
This paper examines mutual fund predictability for common stock funds, using a sample free of survivorship bias, andmeasures performance using risk-adjusted returns. We reconfirm the hot hands result that high return can predict high return in the short run. Like Hendricks, Patel and Zeckhauser, we find that past performance is predictive of future risk-adjusted performance in both the short run and longer run. Furthermore, when we utilize modern portfolio theory (MPT) techniques to allocate capital among funds, we can construct a portfolio of funds based on prior data that significantly outperforms a rule based on past rank alone and that produces a positive risk-adjusted excess return. In addition, we demonstrate the improvement in performance using MPT by selecting a combination of actively managed portfolios that has the same risk as a portfolio of index funds but has higher mean return. While consistent with past studies, our study finds that expenses account for only part of the differences in performance across funds. We find that there is still predictability even after the major impacts of expenses have been removed. Throughout our study we are able to construct portfolios of funds that have small but statistically significant positive risk-adjusted returns during a period where mutual funds in general had negative risk-adjusted returns.

Abstract:
A great deal of the literature in financial economics contains the assumption that returns are a linear function of a set of observable factors. The specification of the variables in the linear process (known as the return-generating process) is one of the key issues in finance today. The return-generating process is an important building block in asset pricing models, portfolio optimization models, mutual fund evaluation, and event studies. For many purposes (such as in developing asset pricing models and evaluationg mutual fund performance), it is important to separate systematic from non-systematic factors. There have been numerous attempts to examine the number and type of systematic factors in equity returns. The purpose of this study is to determine the systematic factors by examining mutual fund returns. One important implication of modern portfolio theory is that, given a belief about systematic factors, an investor should select an exposure (beta) to each factor, a level of expected risk-adjusted return (alpha) and a level of residual risk (residual variance). The mutual fund industry has an incentive to offer an array of exposures to systematic factors in order to meet investors' differing objective functions. Therefore, mutual funds provide a logical way to obtain portfolios which have spread on the characteristics of interest while smothering much of the noise inherent when a model is fitted to individual security returns.

Abstract:
A great deal of the literature in financial economics contains the assumption that returns are a linear function of a set of observable factors. The specification of the variables in the linear process (known as the return-generating process) is one of the key issues in finance today. The return-generating process is an important building block in asset pricing models, portfolio optimization models, mutual fund evaluation, and event studies. For many purposes (such as in developing asset pricing models and evaluationg mutual fund performance), it is important to separate systematic from non-systematic factors. There have been numerous attempts to examine the number and type of systematic factors in equity returns. The purpose of this study is to determine the systematic factors by examining mutual fund returns. One important implication of modern portfolio theory is that, given a belief about systematic factors, an investor should select an exposure (beta) to each factor, a level of expected risk-adjusted return (alpha) and a level of residual risk (residual variance). The mutual fund industry has an incentive to offer an array of exposures to systematic factors in order to meet investors' differing objective functions. Therefore, mutual funds provide a logical way to obtain portfolios which have spread on the characteristics of interest while smothering much of the noise inherent when a model is fitted to individual security returns.

Abstract:
Many financial institutions employ outside portfolio managers to manage part or all of their investable assets. These institutions include pension funds, private endowments (e.g., colleges and charities), and private trusts. In 1999, the investment company institute estimated that these institutions managed 5.2 trillion dollars in assets. Most of these institutions employed outside managers to invest these funds. The relevancy of this problem has been widely recognized in the practitioners literature on portfolio. Furthermore, it is recognized in the prudent man law that spells out the responsibilities of the centralized decision maker delegating management responsibility.2 For example the New York State law in estate power and trust states. Pension funds are the largest and most likely organizations to employ several outside managers, each of whom manages a part of the overall portfolio. In this paper we will use the pension fund manager as the prototype of the centralized decision-maker trying to optimally manage a set of decentralized portfolio managers but the analysts is general.

Abstract:
Many financial institutions employ outside portfolio managers to manage part or all of their investable assets. These institutions include pension funds, private endowments (e.g., colleges and charities), and private trusts. Pension funds are the largest and most likely organizations to employ several outside managers, each of whom manages a part of the overall portfolio. In this paper we will use the pension fund manager as the prototype of the centralized decision-maker trying to optimally manage a set of decentralized decision-makers but the analysts is general. If the centralized decision-maker (CDM) is a mean variance maximizer, the CDM could construct a portfolio using standard portfolio theory and estimates of mean return, variances, and covariances between the portfolios constructed by a group of decentralized managers. However, this overall portfolio is unlikely to be optimum since the individually managed portfolios themselves were constructed without taking into account the portfolios of the other managers. The purpose of this article is to set up a structure that leads to the optimum portfolio from the viewpoint of the CDM when there are multiple managers and their portfolios are constructed without reference to each other.

Abstract:
Many financial institutions employ outside portfolio managers to manage part or all of their investable assets. These institutions include pension funds, private endowments (e.g., colleges and charities), and private trusts. Pension funds are the largest and most likely organizations to employ several outside managers, each of whom manages a part of the overall portfolio. In this paper we will use the pension fund manager as the prototype of the centralized decision-maker trying to optimally manage a set of decentralized decision-makers but the analysts is general. If the centralized decision-maker (CDM) is a mean variance maximizer, the CDM could construct a portfolio using standard portfolio theory and estimates of mean return, variances, and covariances between the portfolios constructed by a group of decentralized managers. However, this overall portfolio is unlikely to be optimum since the individually managed portfolios themselves were constructed without taking into account the portfolios of the other managers. The purpose of this article is to set up a structure that leads to the optimum portfolio from the viewpoint of the CDM when there are multiple managers and their portfolios are constructed without reference to each other.

Abstract:
Many financial institutions employ outside portfolio managers to manage part or all of their investable assets. These institutions include pension funds, private endowments (e.g., colleges and charities), and private trusts. In 1999, the investment company institute estimated that these institutions managed 5.2 trillion dollars in assets. Most of these institutions employed outside managers to invest these funds. The relevancy of this problem has been widely recognized in the practitioners literature on portfolio? Furthermore, it is recognized in the prudent man law that spells out the responsibilities of the centralized decision maker delegating management responsibility.2 For example the New York State law in estate power and trust states. Pension funds are the largest and most likely organizations to employ several outside managers, each of whom manages a part of the overall portfolio. In this paper we will use the pension fund manager as the prototype of the centralized decision-maker trying to optimally manage a set of decentralized portfolio managers but the analysts is general.

Abstract:
In this paper we use data on the monthly holdings for a set of mutual funds to study the timing ability of these funds. These data differ from holdings data used in previous studies in that our holdings data have a higher frequency and include a full range of securities (e.g., options, bonds and futures), not just traded equities. By examining monthly holdings we are able to see how management changes the risk parameters and industry holdings in a fund and to examine how this contributes to timing. We find evidence that timing decisions result in a decrease in performance, whether timing is measured using conditional or unconditional sensitivities. Likewise, sector rotation decisions also result in lower returns. Examining the results for individual sectors shows that the majority of the negative impact on returns from sector rotation comes about because of a fund mis-timing its exposure to high-tech stocks.

mutual funds, portfolios, composition, timing

Abstract:
To implement mean variance analysis one needs a technique for forecasting correlation coefficients. In this article we investigate the ability of several techniques to forecast correlation coefficients between securities. We find that separately forecasting the average level of pair-wise correlations and individual pair-wise differences from the average improves forecasting accuracy. Furthermore, forming homogenous groups of firms on the basis of industry membership or firm attributes (eg. Size) improves forecast accuracy. Accuracy is evaluated in two ways: First, in terms of the error in estimating future correlation coefficients. Second, in the characteristics of portfolios formed on the basis of each forecasting technique. The ranking of forecasting techniques is robust across both methods of evaluation and the better techniques outperform prior suggestions in the literature of financial economics.

Abstract:
To implement mean variance analysis one needs a technique for forecasting correlation coefficients. In this article we investigate the ability of several techniques to forecast correlation coefficients between securities. We find that separately forecasting the average level of pair-wise correlations and individual pair-wise differences from the average improves forecasting accuracy. Furthermore, forming homogenous groups of firms on the basis of industry membership or firm attributes (eg. Size) improves forecast accuracy.

Abstract:
In 1970 Elton and Gruber (hereafter E&G) started an industry by studying the impact of taxes on investor decisions using the behavior of share prices around the ex-dividend date. E&G showed that if taxes enter investors decisions, then the fall in price on the ex-dividend day should reflect the post-tax value of the dividend relative to the post-tax value of capital gains on that day. Because dividends in most time periods are taxed more heavily than capital gains, the theory suggests that if taxes affect investor s choices, the fall in stock price should in general be less than the dividend.

Abstract:
Mutual fund attrition can create problems for a researcher, because funds that disappear tend to do so due to poor performance. In this paper we estimate the size of the bias by tracking all funds that existed at the end of 1976. When a fund merges we calculate the return, taking into account the merger terms. This allows a precise estimate of survivorship bias. In addition, we examine characteristics of both mutual funds that merge and their partner funds. Estimates of survivorship bias over different horizons and using different models to evaluate performance are provided.

Abstract:
Mutual fund attrition can create problems for a researcher, because funds that disappear tend to do so due to poor performance. In this paper we estimate the size of the bias by tracking all funds that existed at the end of 1976. When a fund merges we calculate the return, taking into account the merger terms. This allows a precise estimate of survivorship bias. In addition, we examine characteristics of both mutual funds that merge and their partner funds. Estimates of survivorship bias over different horizons and using different models to evaluate performance are provided.

Abstract:
Mutual fund attrition can create problems for a researcher, because funds that disappear tend to do so due to poor performance. In this paper we estimate the size of the bias by tracking all funds that existed at the end of 1976. When a fund merges we calculate the return, taking into account the merger terms. This allows a precise estimate of survivorship bias. In addition, we examine characteristics of both mutual funds that merge and their partner funds. Estimates of survivorship bias over different horizons and using different models to evaluate performance are provided.

Abstract:
The valuation of corporate debt is an important issue in asset pricing. While there has been an enormous amount of theoretical modeling of corporate bond prices, there has been relatively little empirical testing of these models 1 . Recently there has been extensive development of rating based reduced form models. These models take as a premise that bonds when grouped by ratings are homogeneous with respect to risk. For each risk group the models require estimates of several characteristics such as the spot yield curve, the default probabilities and the recovery rate. These estimates are then used to compute the theoretical price for each bond in the group. The purpose of this article is to examine the pricing of corporate bonds when bonds are grouped by ratings, and to investigate the ability of characteristics, in addition to bond ratings, to improve the performance of rating based models. Most of our testing will be conducted in models which are in the spirit of the theory developed by Duffie and Singleton (1997) and Duffie (1999) The paper is divided into three sections. In the first section, we discuss various reduced form models that have been suggested in the literature. In the second section we examine how well standard classifications serve as a metric for forming homogeneous groups. In this section we show that using standard classifications results in errors being systematically related to specific bond characteristics. Finally, in the last section we take account of these specific bond characteristics in our estimation procedure for determining spot prices and show how this lead to improved estimates of corporate bond prices.

Abstract:
The valuation of corporate debt is an important issue in asset pricing. While there has been an enormous amount of theoretical modeling of corporate bond prices, there has been relatively little empirical testing of these models. Recently there has been extensive development of rating based reduced form models. These models take as a premise that bonds when grouped by ratings are homogeneous with respect to risk. For each risk group the models require estimates of several characteristics such as the spot yield curve, the default probabilities and the recovery rate. These estimates are then used to compute the theoretical price for each bond in the group. The purpose of this article is to examine the pricing of corporate bonds when bonds are grouped by ratings, and to investigate the ability of characteristics, in addition to bond ratings, to improve the performance of rating based models. Most of our testing will be conducted in models which are in the spirit of the theory developed by Duffie and Singleton (1997) and Duffie (1999).

Abstract:
Many investors confine their mutual fund holdings to a single fund family, either for simplicity or through restrictions placed by their retirement savings plan. We find evidence that mutual fund returns are more closely correlated within than between fund families. As a result, restricting investment to one fund family leads to a greater total portfolio risk than diversifying across fund families. The increased correlation is dueprimarily to common stock holdings, but is also more generally related to families having similar exposures to economic sectors or industries. Fund families also show a propensity to focus on high risk or low risk strategies, which leads to a greater dispersion of risk across restricted investors. An investor considering adding an additional fund either inside or outside the family would need to believe the inside fund offered an additional 50 to 70 basis points in return to achieve the same Sharpe ratio.

Abstract:
Many investors confine their mutual fund holdings to a single fund family, either for simplicity or through restrictions placed by their retirement savings plan. We find evidence that mutual fund returns are more closely correlated within fund families, which reduces the benefits of investor diversification. The increased correlation is due primarily to common stock holdings, but is also more generally related to families having similar exposures to economic sectors or industries. Fund families also show a propensity to focus on high risk or low risk strategies, which leads to a greater dispersion of risk across restricted investors.

Abstract:
In this paper, we develop relative pricing (APT) models that are successful in explaining expected returns in the bond market. We utilize indexes as well as unanticipated changes in economic variables as factors driving security returns. An innovation in this paper is the measurement of the economic factors as changes in forecasts. The return indexes are the most important variables in explaining the time series of returns. However, the addition of the economic variables leads to a large improvement in the explanation of expected returns. Furthermore, when we examine the percentage of expected returns explained by each of the variables, the economic variables are much more significant than all indexes with the exception of an aggregate index. We utilize our relative pricing models to examine the performance of bond funds. Bond funds underperform the returns predicted by the relative pricing models by the amount of expenses, on average.

Abstract:
In this paper, we develop relative pricing (APT) models that are successful in explaining expected returns in the bond market. We utilize indexes as well as unanticipated changes in economic variables as factors driving security returns. An innovation in this paper is the measurement of the economic factors as changes in forecasts. The return indexes are the most important variables in explaining the time series of returns. However, the addition of the economic variables leads to a large improvement in the explanation of expected returns. We utilize our relative pricing models to examine the performance of bond funds.

Abstract:
Defined-contribution plans represent a major organizational form for investors retirement savings. Today more than one third of all workers are enrolled in 401K plans. In a 401K plan, participants select assets from a set of choices designated by an employer. For over half of 401K-plan participants, retirement savings represent their sole financial asset. Yet to date there has been no study of the adequacy of the choices offered by 401K plans. This paper analyzes the adequacy and characteristics of the choices offered to 401K-plan participants for over 400 plans. We find that, for 62% of the plans, the types of choices offered are inadequate, and that over a 20-year period this makes a difference in terminal wealth of over 300%. We find that funds included in the plans are riskier than the general population of funds in the same categories. We study the characteristics of plans that are associated with adequate investment choices, including an analysis of the use of company stock, plan size, and the use of outside consultants. When we examine one category of investment choices, S&P 500 index funds, we find that the index funds chosen by 401K-plan administrators are on average inferior to the S&P 500 index funds selected by the aggregate of all investors.

401K plans, pension, spanning, portfolio, investment choices

Abstract:
Defined-contribution plans represent a major organizational form for investors retirement savings. Today more than one third of all workers are enrolled in 401K plans. In a 401K plan, participants select assets from a set of choices designated by an employer. For over half of 401K-plan participants, retirement savings represent their sole financial asset. Yet to date there has been no study of the adequacy of the choices offered by 401K plans. This paper analyzes the adequacy and characteristics of the choices offered to 401K-plan participants forover 400 plans. We find that, for 62% of the plans, the types of choices offered are inadequate, and that over a 20-year period this makes a difference in terminal wealth of over 300%. We find that funds included in the plans are riskier than the general population of funds in the same categories. We study the characteristics of plans that are associated with adequate investment choices, including an analysis of the use of company stock, plan size, and the use of outside consultants. When we examine one category of investment choices, S&P 500 index funds, we find that the index funds chosen by 401K-plan administrators are on average inferior to the S&P 500 index funds selected by the aggregate of all investors.

401K plans, pension, pension, spanning, portfolio, investment choices

Abstract:
In a recent article in this journal, Canner, Mankiw and Weil (CMV) argue that in general popular investment advice, and in particular the investment advice of four investment advisors, is inconsistent with modern portfolio theory and is irrational. As CMV state, since portfolio theory is so well known and easy to implement, finding irrationality here has serious implications for the assumption of rationality throughout economics. As part of their analysis, CMV assert that investment advice can only be viewed as rational if the ratio of bonds to stocks either remains constant or increases as the investor seeks higher return (takes on more risk). As evidence of advisor irrationality, CMV point out that investor advisors frequently advocate decreases in the ratio of bonds to stocks to obtain higher returns. They state, "Although we cannot rule out the possibility that popular advice is consistent with some model of rational behavior, we have so far been unable to find such a model."

Abstract:
This paper examines problems in the CRSP Survivor Bias Free U.S. Mutual Fund Database (CRSP, 1998) and compares returns contained in it to those in Morningstar. The CRSP database has an omission bias that has the same effects as survivorship bias. Although all mutual funds are listed in CRSP, return data is missing for many and the characteristics of these funds differ from the populations. The CRSP return data is biased upward and merger months are inaccurately recorded about half the time. Differences in returns in Morningstar and CRSP are a problem for older data and small funds.

Abstract:
This paper examines problems in the CRSP Survivor Bias Free U.S. Mutual Fund Database CRSP, 1998! and compares returns contained in it to those in Morningstar.The CRSP database has an omission bias that has the same effects as survivorship bias. Although all mutual funds are listed in CRSP, return data is missing for many and the characteristics of these funds differ from the populations. The CRSP return data is biased upward and merger months are inaccurately recorded about half the time. Differences in returns in Morningstar and CRSP are a problem for older data and small funds.

Abstract:
To implement mean variance analysis one needs a technique for forecasting correlation coefficients. In this article we investigate the ability of several techniques to forecast correlation coefficients between securities. We find that separately forecasting the average level of pairwise correlations and individual pairwise differences from the average improves forecasting accuracy. Furthermore, forming homogenous groups of firms on the basis of industry membership or firm attributes (e.g. size) improves forecast accuracy. Accuracy is evaluated in two ways: First, in terms of the error in estimating future correlation coefficients. Second, in the characteristics of portfolios formed on the basis of each forecasting technique. The ranking of forecasting techniques is robust across both methods of evaluation and the better techniques outperform prior suggestions in the literature of financial economics.

Abstract:
This paper examines asset pricing theories for treasury bonds using longer maturities than previous studies and employing a simple multi-factor model. We allow bond factor loadings to vary over time according to term structure variables. The model examines not only the time variation in the expected returns of bonds but also their unexpected returns. This allows us to explicitly test some asset pricing restrictions which are difficult to study under existing frameworks. We confirm that the pure expectation theory of the term structure of interest rates is rejected by the data. Our empirical study of a two-factor model finds substantial evidence of time-varying term-premiums and factor loadings. The fact that factor loadings vary with long term interest rates and yield spreads suggest that bond return volatilities are sensitivity to interest rate levels.

nonlinear cross-equation restriction, asset pricing, bond returns

Abstract:
The popular finance literature describes the asset allocation decision as one of the most important factors in determining investment performance. This article reviews the implications of modern portfolio theory for the asset allocation decision and then examines the recommendations of some leading financial experts to see if they are consistent with theory.

Abstract:
Results of recent research indicate small investor sentiment, as measured by the change in the discount on closed-end funds, is an important factor in the return-generating process for common stocks. We find no evidence of it being an important factor in the return-generating process. We next examine its impact on expected returns and whether one set of firms with high sensitivity to this factor, closed-end funds, offers, and can be expected to offer a higher expected return. Our findings do not support small investor sentiment as a priced factor, either in common stocks or closed-end funds.

Abstract:
In this paper, we develop relative-pricing (APT) models that are successful in explaining expected returns in the bond market. We utilize indexes as well as unanticipated changes in economic variables as factors driving security returns. An innovation in this paper is the measurement of the economic factors as changes in forecasts. The return indexes are the most important variables in explaining the time series of returns. However, the addition of the economic variables leads to a large improvement in explaining the cross-section of expected returns. Weutilize our relative-pricing models to examine the performance of bond funds.

Abstract:
The Financial Economists Roundtable (FER) is a group of senior financial economists who have made significant contributions to the finance literature and seek to apply their knowledge to current policy debates. The Roundtable focuses on microeconomic issues in investments, corporate finance, and financial institutions and markets, both in the U.S. and internationally. Its major objective is to create a forum for intellectual interaction that promotes in-depth analyses of current policy issues in order to raise the level of public and private policy debate and improve the quality of policy decisions.FER was founded in 1993 and meets annually. Members attending a FER meeting discuss specific policy issues on which statements may be adopted. When a statement is issued, it reflects a consensus among at least two-thirds of the attending members and is signed by all members supporting it. The statements are intended to increase the awareness and understanding of public policy makers, the financial economics profession, the communications media, and the general public. FER statements are distributed to the financial and economic academic and practitioner communities, relevant policy makers, and the media.