Investing in Mutual Funds When Returns are Predictable

58 Pages Posted: 8 Jun 2004

See all articles by Doron Avramov

Doron Avramov

Interdisciplinary Center (IDC) Herzliyah

Russ Wermers

University of Maryland - Robert H. Smith School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: March 15, 2005

Abstract

This paper analyzes the performance of portfolio strategies that invest in no-load, open-end U.S. domestic equity mutual funds, incorporating predictability in (i) manager skills, (ii) fund risk-loadings, and (iii) benchmark returns. Predictability in manager skills is found to be the dominant source of investment profitability -- long-only strategies that incorporate such predictability considerably outperform prior-documented "hot-hands" and "smart-money" strategies, and generate positive and significant performance with respect to the Fama-French and momentum benchmarks. Specifically, these strategies outperform their benchmarks by 2-4% per year through their ability to time industries over the business cycle. Moreover, they choose individual funds that outperform their industry benchmarks to achieve an additional 3-6% per year. Overall, our findings indicate that industries are important in locating outperforming mutual funds, and that active management adds much more value than documented by prior studies.

Keywords: Equity mutual fund, asset allocation, manager skills, business cycle

JEL Classification: G11, G12, C11

Suggested Citation

Avramov, Doron and Wermers, Russell R., Investing in Mutual Funds When Returns are Predictable (March 15, 2005). Available at SSRN: https://ssrn.com/abstract=555462 or http://dx.doi.org/10.2139/ssrn.555462

Doron Avramov (Contact Author)

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

Russell R. Wermers

University of Maryland - Robert H. Smith School of Business ( email )

Department of Finance
College Park, MD 20742-1815
United States
301-405-0572 (Phone)
301-405-0359 (Fax)

HOME PAGE: http://www.rhsmith.umd.edu/finance/rwermers/

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