In Search of True Performance: Testing Benchmark-Model Validity in Managed Funds Context
44 Pages Posted: 27 Apr 2000
Date Written: undated
With the recent surge in Managed Funds sector of the financial markets, the ability to accurately measure the risk-adjusted performance of these funds has become vital. To this end we have set out to analyse a set of benchmarks with a view to assessing their comparative results as well as their individual efficiencies. Using an ASSIRT database on Australian managed funds we mitigate any data mining bias affecting US studies, as well as provide an international perspective on the managed fund performances. The examined benchmarks - which included 1) All Ordinaries Index, 2) Equally-Weighted 3) Value-Weighted and 4) Price-Weighted Index, 5) Fama and French' 3-Factor Portfolio, 6) Carhart's 4-Factor Portfolio, 7) Grinblatt & Titman's 8-Portfolio Benchmark, 8) Ferson and Schadt' Conditional Expectations Model and its modified version used by 9) Sawicki and Ong - were tested using the Jensen's alpha model, as well as the selectivity-timing decomposition models proposed by Treynor & Mazuy and Henriksson & Merton. We have also tested for the relative importance of three risk-free return proxies that coincide with 1) proxy used in general literature, 2) maturity of assets held by managed funds and 3) average life-span of managed funds. To control for several unique characteristics associated with new funds and funds nearing their demise, we have subdivided our sample period into three five-year time frames between 1985 and 1999. Finding that the choice of benchmark has a significant impact on the measured excess returns both with and without market-timing adjustment, we have next analysed the individual efficiency of each benchmark and each measurement model. To this end we have conducted tests against a set of passive portfolios that were controlled for known market biases, on the presumption that a lack of private information in the construction of such portfolios should produce zero abnormal return (as per Grinblatt and Titman, 1989). In the next stage we have examined the persistence in performance of managed funds by looking at relative changes in the above results across three sub-periods. Finally we have recognised that 1) the above benchmarking methods are heavily (if not exclusively) biased towards testing of equity funds and 2) apart from selectivity and market timing, managed fund managers can also improve their returns through prudent asset allocation. We have therefore proposed and tested an innovative measure based on asset allocations, thus producing a benchmark that can be used independently of the fund's asset structure.
JEL Classification: G11, G12, G23
Suggested Citation: Suggested Citation