Investment Criteria for Mutual Fund Selection
(Sprache: Englisch)
The importance of mutual funds for individual investors has increased in recent decades. This becomes apparent when looking at the increased share of households owning mutual funds. These mutual fund investors usually want to receive a return which is above...
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The importance of mutual funds for individual investors has increased in recent decades. This becomes apparent when looking at the increased share of households owning mutual funds. These mutual fund investors usually want to receive a return which is above or at least close to the mutual fund's benchmark. Consequently, investors want to invest in those funds which will show these patterns in the future. Some of these mutual funds receive much attention, since they generate extraordinary high performance. But the question that remains is whether it is possible to predict such performance before funds exhibit such outstanding performance.In the past, mutual fund investors focused extensively on performance or performance linked patterns, like the Morningstar star rating, and thus chased past performance. This seems surprising since performance persists only over a short time and is more persistent to weak mutual funds (1 and 2 star rated) than well performing mutual funds. Thus, chasing past performances seems to be a rather inferior strategy. Therefore, investors should try to identify alternative tools showing a high correlation to future mutual fund performance.
In this book, mutual funds are analysed, especially open-end mutual funds and actively managed mutual funds. The main focus is on what purpose and usefulness active investments have and whether performance is persistent and what the determinants of mutual fund flows are. Moreover, some alternative measures will be introduced by explaining which attributes or methods should be used and avoided when selecting mutual funds.
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Text sample:Chapter 3 Mutual Fund Performance:
3.1 What is Important about Mutual Fund Performance:
Ratings mainly based on performance and fund performance itself are the dominant investment criteria when looking at mutual funds. Especially the influence of the star rating becomes apparent when observing the market reactions following changes in Morningstar fund ratings in the USA. When looking at the mutual fund literatures regarding the performance of mutual funds, three main scopes are important:
Are mutual fund managers able to outperform their benchmark by generating a true alpha? In other words: Are mutual fund managers really skilled? The empirical evidence shows that skill seems to be a scare source and that the short run performance is mainly derived by luck, good luck as well as bad luck.
The next scope is predictability and persistence in mutual fund performance. This is obviously difficult since performance is used to predict performance and performance is at least partly a random walk. Furthermore, performance persistence is rather a short run phenomenon and is rather a result compared with worse performing mutual funds.
Mutual fund flows are of special interest, since both the fund's performance influences the asset flows in and out of funds and the flows influence the performance and vice versa. The performance directly influences the fund flows, as investors chase past performance. Inflows on the other hand lead to increasing assets under management and the funds face decreasing economies of scale.
3.2 Active Investments:
3.2.1 Why Using Active Strategies?:
Investors use active investment strategies to outperforming a corresponding passive alternative. Otherwise it would be rational to invest the assets in passive strategies like an ETF, which yields the benchmark return minus marginal costs for "sure", without the risk of underperforming the benchmark substantially. Due to the fact that stocks in active mutual funds are traded actively
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and thus have other weights than the benchmark, they may show higher risks than their passive counterparts. Furthermore, active mutual funds charge higher fees on the expense of their investors to remunerate managerial skill, research costs and higher trading costs. Unfortunately studies show that at least on average outperforming passive strategies is hardly possible or even impossible as on average a negative alpha indicates. Investors are going to anticipate the inability to receive excess returns (in the long run) and now only want to collect at least the return of the passive benchmark (alpha equals zero).
3.2.2 Skill in the Mutual Fund Industry:
Assuming fairly efficient markets it seems apparent that mutual fund managers need skill or superior information to outperform the market. Otherwise no rational investor would put any money in an active mutual fund, since it would be a zero sum or even a losing game. Skill can be defined either as the managers' ability to generate a true positive alpha after costs or a true positive alpha before costs. The second definition might be justifiable since the expenses charged are not essentially linked to the management itself. But nevertheless investors only receive net returns, thus the second definition is rather a theoretical one. Skill is derived either due to stock picking ability or market timing ability, whereas stock picking ability may be simply linked to superior information, provided by managers of firms the fund is invested in. Based on the assumption above, skill would be expressed in two different ways, increasing the return of a portfolio or minimizing the "insurable risk" and so increase risk adjusted returns. This is important since investors usually show some risk aversion and thus prefer less risky investments instead of risky ones when yielding the same expected return. The risk aversion applies as long as the probability of the outcome is not extremely unlikely, which gives investors incentives for gam
3.2.2 Skill in the Mutual Fund Industry:
Assuming fairly efficient markets it seems apparent that mutual fund managers need skill or superior information to outperform the market. Otherwise no rational investor would put any money in an active mutual fund, since it would be a zero sum or even a losing game. Skill can be defined either as the managers' ability to generate a true positive alpha after costs or a true positive alpha before costs. The second definition might be justifiable since the expenses charged are not essentially linked to the management itself. But nevertheless investors only receive net returns, thus the second definition is rather a theoretical one. Skill is derived either due to stock picking ability or market timing ability, whereas stock picking ability may be simply linked to superior information, provided by managers of firms the fund is invested in. Based on the assumption above, skill would be expressed in two different ways, increasing the return of a portfolio or minimizing the "insurable risk" and so increase risk adjusted returns. This is important since investors usually show some risk aversion and thus prefer less risky investments instead of risky ones when yielding the same expected return. The risk aversion applies as long as the probability of the outcome is not extremely unlikely, which gives investors incentives for gam
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Bibliographische Angaben
- Autor: Jan Harkopf
- 2016, 92 Seiten, Maße: 15,5 x 22 cm, Kartoniert (TB), Englisch
- Verlag: Anchor Academic Publishing
- ISBN-10: 3960670761
- ISBN-13: 9783960670766
- Erscheinungsdatum: 30.09.2016
Sprache:
Englisch
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