Do Active Funds Perform Better in Down Markets? New Evidence from Cross-Sectional Study

59 Pages Posted: 18 Sep 2009 Last revised: 2 Nov 2009

See all articles by Zheng Sun

Zheng Sun

University of California, Irvine - Paul Merage School of Business

Ashley Wang

Federal Reserve Board

Lu Zheng

University of California, Irvine - Paul Merage School of Business

Date Written: September 1, 2009

Abstract

As discussed in Gruber (1996), the dramatic growth of actively managed funds constitutes a major puzzle in the finance literature. Despite the large amount of money invested in actively managed funds, these funds on average underperform their passive counterparts after fees. The existing literature proposes a potential explanation to the puzzle - active funds perform better in down markets when it matters the most to investors. However, empirical conclusions are hard to draw due to the short time series of data relative to the length of a business cycle. In this paper, we exploit the large panel of mutual fund data, and study the cross-sectional variation in performance cyclicality. Using data from 1980-2008, we find that the most active funds outperform the least active ones by 4.5 percent to 6.1 percent per year in down markets after adjusting for risk and expenses. On the other hand, the most active funds do not outperform in the up markets. A further investigation of the sources of fund performance suggests that active funds show better stock picking skills in the down markets. The results are robust to different measures of fund activeness and definitions of up and down markets.

Keywords: Active management, business cycle, mutual funds, performance

JEL Classification: G11

Suggested Citation

Sun, Zheng and Wang, Ashley and Zheng, Lu, Do Active Funds Perform Better in Down Markets? New Evidence from Cross-Sectional Study (September 1, 2009). Available at SSRN: https://ssrn.com/abstract=1474083 or http://dx.doi.org/10.2139/ssrn.1474083

Zheng Sun (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States

Ashley Wang

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Lu Zheng

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States
9498248365 (Phone)

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