Luck versus Skill in the Cross-Section of Mutual Fund Returns: Reexamining the Evidence

62 Pages Posted: 2 Jul 2020

See all articles by Campbell R. Harvey

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Yan Liu

Purdue University

Date Written: June 9, 2020

Abstract

Can fund managers beat the market? This is a key economic question as well as an important practical issue for investors. However, prominent academic research offers conflicting answers. Even though Kosowski et al. (2006) and Fama and French (2010) use bootstrap methods to evaluate whether mutual funds outperform, their conclusions are very different. We reconcile their findings. Fama and French capture the cross-section of mutual fund returns, which is attractive from an economic perspective, whereas Kosowski et al. conduct a fund-by-fund analysis. We show that the Fama and French method suffers from an undersampling problem that leads to a failure to reject the null hypothesis of zero alpha, even when some funds generate economically large risk-adjusted returns. In contrast, Kosowski et al. avoid the undersampling problem, but substantially over reject the null hypothesis, even when all funds have a zero alpha. Hence, the truth about mutual fund performance likely lies between the two findings. We present a novel bootstrapping approach that should be useful to future researchers who are choosing between the two approaches.

Keywords: Performance evaluation, alpha, active management, bootstrapping, market efficiency, fund management, oversampling, undersampling, Type I errors, Type II errors

JEL Classification: G11, G12, G23, C58

Suggested Citation

Harvey, Campbell R. and Liu, Yan, Luck versus Skill in the Cross-Section of Mutual Fund Returns: Reexamining the Evidence (June 9, 2020). Available at SSRN: https://ssrn.com/abstract=3623537

Campbell R. Harvey

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)

HOME PAGE: http://www.duke.edu/~charvey

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yan Liu (Contact Author)

Purdue University ( email )

West Lafayette, IN 47907-1310
United States

HOME PAGE: http://yliu1.com

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