Evaluating and Investing in Equity Mutual Funds
54 Pages Posted: 13 Jun 2000
Date Written: May 2000
Our framework for evaluating and investing in mutual funds combines observed returns on funds and passive assets with prior beliefs that distinguish pricing-model inaccuracy from managerial skill. A fund's "alpha" is defined using passive benchmarks. We show that returns on non-benchmark passive assets help estimate that alpha more precisely for most funds. The resulting estimates generally vary less than standard estimates across alternative benchmark specifications. Optimal portfolios constructed from a large universe of equity funds can include actively managed funds even when managerial skill is precluded. The fund universe offers no close substitutes for the Fama-French and momentum benchmarks.
JEL Classification: G12, G14
Suggested Citation: Suggested Citation