R. R. Wermers, “Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style,
Mark M. Carhart, “On Persistence in Mutual Fund Performance,” Journal of Finance 52 (1997), pp. 57–82.
Nicolas P. B. Bollen and Jeffrey A. Busse, “Short-Term Persistence in Mutual Fund Performance,” Review
C H A P T E R
1 1
The Efficient Market Hypothesis
379
This pattern is actually consistent with the prediction of an influential paper by Berk
and Green.
59
They argue that skilled mutual fund managers with abnormal performance
will attract new funds until the additional costs and complexity of managing those extra
funds drive alphas down to zero. Thus, skill will show up not in superior returns, but rather
in the amount of funds under management. Therefore, even if managers are skilled, alphas
will be short-lived, as they seem to be in Figure 11.8 .
Del Guercio and Reuter
60
offer a finer interpretation of mutual fund performance and
the Berk and Green hypothesis. They split mutual fund investors into those who buy funds
directly for themselves versus those who purchase funds through brokers, reasoning that
the direct-sold segment may be more financially literate while the broker-sold segment is
less comfortable making financial decisions without professional advice. Consistent with
this hypothesis, they show that direct-sold investors direct their assets to funds with posi-
tive alphas (consistent with the Berk-Green model), but broker-sold investors generally do
not. This provides a greater incentive for direct-sold funds to invest relatively more in alpha-
generating inputs such as talented portfolio managers or analysts. Moreover, they show that
the after-fee performance of direct-sold funds is as good as that of index funds (again, consis-
tent with Berk-Green), while the performance of broker-sold funds is considerably worse. It
thus appears that the average underperformance of actively managed mutual funds is driven
largely by broker-sold funds and that this underperformance may be interpreted as an implicit
cost that less informed investors pay for the advice they get from their brokers.
In contrast to the extensive studies of equity fund managers, there have been few studies
of the performance of bond fund managers. Blake, Elton, and Gruber
61
examined the per-
formance of fixed-income mutual funds. They found that, on average, bond funds under-
perform passive fixed-income indexes by an amount roughly equal to expenses, and that
there is no evidence that past performance can predict future performance. More recently,
Chen, Ferson, and Peters (2010) find that on average, bond mutual funds outperform pas-
sive bond indexes in terms of gross returns but underperform once the fees they charge
their investors are subtracted, a result similar to those others have found for equity funds.
Thus the evidence on the risk-adjusted performance of professional managers is mixed
at best. We conclude that the performance of professional managers is broadly consistent
with market efficiency. The amounts by which professional managers as a group beat or
are beaten by the market fall within the margin of statistical uncertainty. In any event, it is
quite clear that performance superior to passive strategies is far from routine. Studies show
either that most managers cannot outperform passive strategies or that if there is a margin
of superiority, it is small.
On the other hand, a small number of investment superstars—Peter Lynch (formerly of
Fidelity’s Magellan Fund), Warren Buffett (of Berkshire Hathaway), John Templeton (of
Templeton Funds), and Mario Gabelli (of GAMCO) among them—have compiled career
records that show a consistency of superior performance hard to reconcile with abso-
lutely efficient markets. In a careful statistical analysis of mutual fund “stars,” Kosowski,
Timmerman, Wermers, and White
62
conclude that the stock-picking ability of a minority of
59
J. B. Berk and R. C. Green, “Mutual Fund Flows and Performance in Rational Markets,” Journal of Political
Economy 112 (2004), pp. 1269–95.
60
Diane Del Guercio and Jonathan Reuter, “Mutual Fund Performance and the Incentive to Generate Alpha,”
Journal of Finance, forthcoming, 2013.
61
Christopher R. Blake, Edwin J. Elton, and Martin J. Gruber, “The Performance of Bond Mutual Funds,” Jour-
nal of Business 66 (July 1993), pp. 371–404.
62
R. Kosowski, A. Timmerman, R. Wermers, and H. White. “Can Mutual Fund ‘Stars’ Really Pick Stocks? New
Evidence from a Bootstrap Analysis,” Journal of Finance 61 (December 2006), pp. 2551–95.
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P A R T I I I
Equilibrium in Capital Markets
managers is sufficient to cover their costs, and that their superior performance tends to per-
sist over time. However, Nobel Prize–winner Paul Samuelson
63
reviewed this investment
hall of fame and pointed out that the records of the vast majority of professional money
managers offer convincing evidence that there are no easy strategies to guarantee success
in the securities markets.
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