Investing in Equity Mutual Funds
37 Pages Posted: 20 Sep 2001
Date Written: August 2001
We construct optimal portfolios of equity funds by combining historical returns on funds and passive indexes with prior views about asset pricing and skill. By including both benchmark and nonbenchmark indexes, we distinguish pricing-model inaccuracy from managerial skill. Even modest confidence in a pricing model helps construct portfolios with high Sharpe ratios. Investing in active mutual funds can be optimal even for investors who believe active managers cannot outperform passive indexes. Optimal portfolios exclude hot-hand funds even for investors who believe momentum is priced. Our large universe of funds offers no close substitutes for the Fama-French and momentum benchmarks.
Keywords: mutual funds, portfolio selection
JEL Classification: G11, G12, C11
Suggested Citation: Suggested Citation