The Journal of Finance

Mutual Fund Performance: An Empirical Decomposition into Stock‐Picking Talent, Style, Transactions Costs, and Expenses

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00263

Russ Wermers

We use a new database to perform a comprehensive analysis of the mutual fund industry. We find that funds hold stocks that outperform the market by 1.3 percent per year, but their net returns underperform by one percent. Of the 2.3 percent difference between these results, 0.7 percent is due to the underperformance of nonstock holdings, whereas 1.6 percent is due to expenses and transactions costs. Thus, funds pick stocks well enough to cover their costs. Also, high‐turnover funds beat the Vanguard Index 500 fund on a net return basis. Our evidence supports the value of active mutual fund management.

Mutual Fund Herding and the Impact on Stock Prices

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00118

Russ Wermers

We analyze the trading activity of the mutual fund industry from 1975 through 1994 to determine whether funds “herd” when they trade stocks and to investigate the impact of herding on stock prices. Although we find little herding by mutual funds in the average stock, we find much higher levels in trades of small stocks and in trading by growth‐oriented funds. Stocks that herds buy outperform stocks that they sell by 4 percent during the following six months; this return difference is much more pronounced among small stocks. Our results are consistent with mutual fund herding speeding the price‐adjustment process.

False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas

Published: 01/13/2010   |   DOI: 10.1111/j.1540-6261.2009.01527.x

LAURENT BARRAS, OLIVIER SCAILLET, RUSS WERMERS

This paper develops a simple technique that controls for “false discoveries,” or mutual funds that exhibit significant alphas by luck alone. Our approach precisely separates funds into (1) unskilled, (2) zero‐alpha, and (3) skilled funds, even with dependencies in cross‐fund estimated alphas. We find that 75% of funds exhibit zero alpha (net of expenses), consistent with the Berk and Green equilibrium. Further, we find a significant proportion of skilled (positive alpha) funds prior to 1996, but almost none by 2006. We also show that controlling for false discoveries substantially improves the ability to find the few funds with persistent performance.

Measuring Mutual Fund Performance with Characteristic‐Based Benchmarks

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb02724.x

KENT DANIEL, MARK GRINBLATT, SHERIDAN TITMAN, RUSS WERMERS

This article develops and applies new measures of portfolio performance which use benchmarks based on the characteristics of stocks held by the portfolios that are evaluated. Specifically, the benchmarks are constructed from the returns of 125 passive portfolios that are matched with stocks held in the evaluated portfolio on the basis of the market capitalization, book‐to‐market, and prior‐year return characteristics of those stocks. Based on these benchmarks, “Characteristic Timing” and “Characteristic Selectivity” measures are developed that detect, respectively, whether portfolio managers successfully time their portfolio weightings on these characteristics and whether managers can select stocks that outperform the average stock having the same characteristics. We apply these measures to a new database of mutual fund holdings covering over 2500 equity funds from 1975 to 1994. Our results show that mutual funds, particularly aggressive‐growth funds, exhibit some selectivity ability, but that funds exhibit no characteristic timing ability.

Can Mutual Fund “Stars” Really Pick Stocks? New Evidence from a Bootstrap Analysis

Published: 01/11/2007   |   DOI: 10.1111/j.1540-6261.2006.01015.x

ROBERT KOSOWSKI, ALLAN TIMMERMANN, RUSS WERMERS, HAL WHITE

We apply a new bootstrap statistical technique to examine the performance of the U.S. open‐end, domestic equity mutual fund industry over the 1975 to 2002 period. A bootstrap approach is necessary because the cross section of mutual fund alphas has a complex nonnormal distribution due to heterogeneous risk‐taking by funds as well as nonnormalities in individual fund alpha distributions. Our bootstrap approach uncovers findings that differ from many past studies. Specifically, we find that a sizable minority of managers pick stocks well enough to more than cover their costs. Moreover, the superior alphas of these managers persist.

Decentralized Investment Management: Evidence from the Pension Fund Industry

Published: 01/30/2013   |   DOI: 10.1111/jofi.12024

DAVID BLAKE, ALBERTO G. ROSSI, ALLAN TIMMERMANN, IAN TONKS, RUSS WERMERS

Using a unique data set, we document two secular trends in the shift from centralized to decentralized pension fund management over the past few decades. First, across asset classes, sponsors replace generalist balanced managers with better‐performing specialists. Second, within asset classes, funds replace single managers with multiple competing managers following diverse strategies to reduce scale diseconomies as funds grow larger relative to capital markets. Consistent with a model of decentralized management, sponsors implement risk controls that trade off higher anticipated alphas of multiple specialists against the increased difficulty in coordinating their risk‐taking and the greater uncertainty concerning their true skills.

Non‐Deal Roadshows, Informed Trading, and Analyst Conflicts of Interest

Published: 11/02/2021   |   DOI: 10.1111/jofi.13089

DANIEL BRADLEY, RUSSELL JAME, JARED WILLIAMS

Non‐deal roadshows (NDRs) are private meetings between management and institutional investors, typically organized by sell‐side analysts. We find that around NDRs, local institutional investors trade heavily and profitably, while retail trading is significantly less informed. Analysts who sponsor NDRs issue significantly more optimistic recommendations and target prices, together with more “beatable” earnings forecasts, consistent with analysts issuing strategically biased forecasts to win NDR business. Our results suggest that NDRs result in a substantial information advantage for institutional investors and create significant conflicts of interests for the analysts who organize them.

PRICE EFFECTS IN RIGHTS OFFERINGS*

Published: 12/01/1965   |   DOI: 10.1111/j.1540-6261.1965.tb02933.x

J. Russell Nelson

Estimating the Divisional Cost of Capital: An Analysis of the Pure‐Play Technique

Published: 12/01/1981   |   DOI: 10.1111/j.1540-6261.1981.tb01071.x

RUSSELL J. FULLER, HALBERT S. KERR

This paper suggests that the pure‐play technique can be used in conjunction with the capital asset pricing model to determine the cost of equity capital for the divisions of a multidivision firm. Since the beta for a division is unobservable in the marketplace, a proxy beta derived from a publicly traded firm whose operations are as similar as possible to the division in question is used as the measure of the division's systematic risk. To provide empirical support for using the pure‐play technique, a sample of multidivision firms and pure‐play associated with each division is examined. It is shown that an appropriately weighted average of the betas of the pure‐play firms closely approximates the beta of the multidivision firm.

A Theoretical Analysis of Real Estate Returns

Published: 07/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb04994.x

H. RUSSELL FOGLER, MICHAEL R. GRANITO, LAURENCE R. SMITH

In this paper, we consider two hypotheses for the recent performance of real estate returns. The first is the random event argument that real estate is positively correlated with unanticipated inflation but that structural change in expected returns due to a change in the perceived sensitivity of returns to unanticipated inflation has not taken place. The second is the hedge demand argument that formulates the structural shift hypothesis. The paucity of real estate and other expectations data as well as the general identification problem make it extremely difficult to distinguish between these hypothesis. Our tests consist of estimates of inflation betas for various asset categories overtime as well as estimates of the hedge vector, S-1C. Although some support for the hedge argument is found, the results are not strong enough to reject the random event argument and conclude that a decline in the required return on real estate due to a relative increase in inflation beta drove returns during the 1970's.

Ripoffs, Lemons, and Reputation Formation in Agency Relationships: A Laboratory Market Study

Published: 07/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb05006.x

DOUGLAS V. DEJONG, ROBERT FORSYTHE, RUSSELL J. LUNDHOLM

This paper examines the effect of the moral hazard problem in an agency relationship where the principal cannot observe the level of service provided by the agent. Using data from laboratory markets, we demonstrate that the presence of moral hazard leads to shirking by agents. However, this “lemons” phenomenon occurs only about one‐half of the time. While there is evidence of reputation effects in these markets, seemingly reputable agents are often able to use opportunities for false advertising to their advantage and “ripoff” principals.

Three Factors, Interest Rate Differentials and Stock Groups

Published: 05/01/1981   |   DOI: 10.1111/j.1540-6261.1981.tb00445.x

H. RUSSELL FOGLER, ROSE JOHN, JAMES TIPTON

REPLY TO SALAMON AND SMITH

Published: 12/01/1977   |   DOI: 10.1111/j.1540-6261.1977.tb03378.x

Ray Ball, Ross Watts

THE CURRENT STATUS OF THE CAPITAL ASSET PRICING MODEL (CAPM)

Published: 06/01/1978   |   DOI: 10.1111/j.1540-6261.1978.tb02029.x

Martin J. Gruber, Stephen A. Ross

Tax Clienteles and Asset Pricing

Published: 07/01/1986   |   DOI: 10.1111/j.1540-6261.1986.tb04540.x

PHILIP H. DYBVIG, STEPHEN A. ROSS

Taxation of asset returns can create various clientele effects. If every agent is marginal on all assets, no clientele effects arise. If some (but not every) agent is marginal on all assets, there arises a clientele effect in quantities but none in prices. If no agent is marginal on all assets, there arise clientele effects in both quantities and prices. In the first two cases, standard asset pricing and martingale results extend to analogous aftertax results. In the third case, linear asset pricing works only on subsets of assets, and the standard martingale results become after‐tax supermartingale results.

Institutional Markets, Financial Marketing, and Financial Innovation

Published: 07/01/1989   |   DOI: 10.1111/j.1540-6261.1989.tb04377.x

STEPHEN A. ROSS

Firms and institutions are monitored and controlled through a complex set of implicit and explicit contractual relations. Because of these agency theoretic relations, institutional behavior in financial markets is not a simple reflection of the preference structures of individuals. Institutional preferences give rise to a demand for new financial instruments and innovations, even when the returns on these instruments are “spanned” in the sense of complete pricing. The innovations can be thought of as solving moral hazard problems. An agency theoretic example serves to illustrate the demand, supply, and financial marketing of stripped securities. In short, institutions matter.

DISCUSSION

Published: 05/01/1976   |   DOI: 10.1111/j.1540-6261.1976.tb00581.x

Ross L. Watts

Information and Volatility: The No‐Arbitrage Martingale Approach to Timing and Resolution Irrelevancy

Published: 03/01/1989   |   DOI: 10.1111/j.1540-6261.1989.tb02401.x

STEPHEN A. ROSS

The no‐arbitrage martingale analysis is used to study the effect on asset prices of changes in the rate of information flow. The analysis is first used to develop some simple tools for asset pricing in a continuous‐time setting. These tools are then applied to determine the effect of information on prices and price volatility, to extend Samuelson's theorem on prices fluctuating randomly, and to study the impact on prices of the resolution of uncertainty. The conditions under which uncertainty resolution is irrelevant for asset pricing are shown to be similar to those which support the MM irrelevance theorems.

The Recovery Theorem

Published: 08/12/2013   |   DOI: 10.1111/jofi.12092

STEVE ROSS

We can only estimate the distribution of stock returns, but from option prices we observe the distribution of state prices. State prices are the product of risk aversion—the pricing kernel—and the natural probability distribution. The Recovery Theorem enables us to separate these to determine the market's forecast of returns and risk aversion from state prices alone. Among other things, this allows us to recover the pricing kernel, market risk premium, and probability of a catastrophe and to construct model‐free tests of the efficient market hypothesis.

Risk Assessments and Risk Premiums in the Eurodollar Market

Published: 06/01/1982   |   DOI: 10.1111/j.1540-6261.1982.tb02217.x

GERSHON FEDER, KNUD ROSS

Increasing awareness of the potential risks involved in lending to heavily indebted governments focuses attention on credit pricing in the Eurodollar market. This paper utilizes a recent survey of country‐by‐country risk assessments as perceived by lenders to show that a systematic relationship exists between these assessments and interest rates in the Euromarket. The relationship is derived from an underlying model described in the paper. The estimated parameters verify a number of hypotheses, providing insights on the loss rates lenders expect to incur in case of default.