Active managers of mutual funds are employed for their skill in increasing investment yields, but according to a study co-authored by a finance professor at the Tuck School of Business, investors who hire managers may actually lose money in the long run. The study, authored by Tuck professor Kenneth French and Eugene Fama, a finance professor at the University of Chicago Booth School of Business, found that active managers often do not increase returns enough to offset the fees investors pay them, and that people might be better off leaving the performance of their mutual funds up to chance.
The professors evaluated data from the Center for Research in Security Prices at the Booth School of Business on all U.S. equity funds from 1984 to 2006, according to French. In analyzing the data, they sought to determine the financial impact of active managers, who attempt to raise mutual funds' returns above a certain benchmark by making specific investment decisions.
French and Fama adjusted the data to "0-alpha," or when "[the active managers] just managed to beat the market by the amount of their expenses," French said. This creates a "by-chance distribution," which reflects how the fund would have performed based on luck. The researchers compared this adjusted data to the actual mutual fund return results of active managers, according to French.
"We found that for 97 percent of [the active managers], they did worse than the by-chance-distribution, and the other 2 to 3 percent had the same performance as the by-chance-distribution indicated," French said in an interview with The Dartmouth. "So people are hurt because they pay fees and expenses to the active managers, but they don't necessarily get better results."
French said he believes that investors are actually losing money by hiring active managers.
"We find that if I pick the top 2 to 3 percent of the top performers [among active managers], their performance looks like the result they would have gotten if they just did what they were supposed to do and the rest were based on chance," French said.
The researchers concluded that investors cannot know for sure how good their active managers' skills are, because even the top performers in active managing could have reached good results simply based on luck, according to the study.
"Most investors would have a better expected return if they put their money in passive funds that do not try to out-guess the market," French said in an e-mail to The Dartmouth.
The study, "Luck Versus Skill in the Cross Section of Mutual Fund Returns," was posted online as a working paper by the Social Science Research Network in March 2009. A revised version of the paper was made available in December 2009. The paper is due to be published in the Journal of Finance in approximately one year, according to French.
