Cheaper is Not Better: On the Superior Performance of High-Fee Mutual Funds

Sheng, Jinfei; Simutin, Mikhail; Zhang, Terry

doi:10.2139/ssrn.2912511

Cited by 7 publications

(6 citation statements)

References 71 publications

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“…Parida and Tang (2018) and Song (2020) claim that such investors are the main reason why funds strategically increase management fees in highly competitive markets. Sheng et al (2022) disagree and explain that high management fees of US active funds are not determined by the naïve behavior of investors, but by difficult and costly valuation of growth companies that are in the portfolios of these funds. The fund managers are compensated for their hard work and they deliver by producing more fund alpha.…”

Section: Discussionmentioning

confidence: 99%

“…However, management company shareholders are in a better position than fund investors, due to the fund manager's behavior potentially aligning with the profit maximization of the company -rather than of the fund investors (Reynolds et al, 2006). This might be a reason as to why the level of a management fee does not reward a realized fund performance (Cooper et al, 2021;Gil-Bazo & Ruiz-Verdu, 2009;Parida & Tang, 2018); though the recent literature also considers the opposite scenario (He et al, 2018;Sheng et al, 2022;Vidal et al, 2015). This study works towards solving this problem since, unlike the demand side of the mutual fund market, its supply side is always very attentive.…”

Section: Literature Reviewmentioning

confidence: 99%

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Actual rate of the management fee in mutual funds of different styles

Perez

Szymczyk

2022

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Research background: Exponential growth of passive mutual funds after 2007?2008 global financial crisis put pressure on active fund managers to lower the management fees. The real costs of active fund management are, however, very often higher than the values of management fees reported publicly. Thus it is not easy to decide on the quality of the fund management and estimate the level of management charges optimal for the future fund performance. Purpose of the article: In this study, we propose to utilize an actual rate of the management fee (ARMF) disclosed in the management company financial statements as a measure of the real value of the management costs and investigate its determinants in mutual funds of different styles. Methods: Using a dataset of 21,618 monthly observations for 500 mutual funds from a market of diversified structure and high management fees charged we test the operating model of a mutual fund performance, and derive the formula of a before-fee return with the ARMF as its component. The fund performance is measured by a raw before-fee return and two types of risk-adjusted alphas based on the multifactor model of Carhart (1997) and the fund attributes. Later, using panel data we explain ARMF by mutual fund performance and attributes. We also compare the results to the ones obtained for the total operational cost (TOC) ? a value similar to ARMF that is disclosed in mutual fund financial reports. Findings & value added: We find that the proposed ARMF is related more to the size and not to the performance, age or a cash flow of mutual funds. We observe it among all studied fund styles. The largest deviations of the average ARMF are seen in the management companies that belong to the banks? capital groups. The proposed measure of the management fee included in the operating model of a mutual fund performance can be used for any local mutual fund worldwide, and compared with other fund markets of more or less diversified style structures.

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Section: Discussionmentioning

confidence: 99%

Section: Literature Reviewmentioning

confidence: 99%

Actual rate of the management fee in mutual funds of different styles

Perez

Szymczyk

2022

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“…Fewer studies are related to relation between performance and fees (Gil-Bazo & Ruiz-Verdú, 2009;Díaz-Mendoza, López-Espinosa & Martínez, 2014;Corzo Santamaría, Martinez de Ibarreta & Rodriguez Calvo, 2018;Fraś, 2018;Cooper, Halling & Yang, 2021;Sheng, Simutin & Zhang, 2021). The studies on the relation between performance and fees revealed a negative relation between the expense ratio and the future performance.…”

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confidence: 99%

Mutual Funds’ Cost Persistence

Trzebiński

2022

Financial Internet Quarterly

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The research aimed to check whether investment fund managers maintain costs similarly from period to period. The research verified the hypothesis that managers maintain costs in the subsequent periods at a similar level. The study used a method based on contingency tables which are used to analyse the persistence of performance. In this study, we replaced performance with costs, assuming that managers also control these values. Costs were defined as: (1) total costs, (2) total costs minus management fees and (3) active management costs (expressed as the active expense ratio). Based on the results obtained, it should be stated that managers maintain costs at a similar level from period to period in the case of the split using the median. On the other hand, the results indicate that the costs were not maintained at a similar level in subsequent periods when broken down into quartiles. Considering the detailed results for funds divided into quartiles, it is clearly visible that most managers keep the costs close to the average value. Less frequently, costs from period to period are changed to be allocated to the extreme quartiles.

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“…I argue, therefore, that the five-factor model serves as a more comprehensive proxy of alternative investment opportunity set. In the same spirit as this argument, Jordan and Riley (2016) and Sheng et al (2017) also show that, in evaluating mutual fund performance, adding profitability and investment factors to the four-factor model considerably improves the tracking efficiency and explanatory power. Hence, I propose testing the performance of activeness strategies using five-factor as a benchmark.…”

Section: Introductionmentioning

confidence: 85%

“…The first benchmark is a six-factor model (similar to Jordan and Riley (2016) and Sheng et al (2017)) that adds the momentum factor of Carhart (1997) to the five-factor model and simultaneously accounts for the exposures to profitability, investment and momentum factors. This model performs consistently better than the four-factor model and the five-factor model in terms of the model fit across all nine activeness strategies.…”

Section: Alternative Benchmark Modelsmentioning

confidence: 99%

Essays on return predictability and active management

Kothari¹

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In this dissertation, I consider two topics in return predictability and performance evaluation in active management. In the first essay, I propose a production based asset pricing model with labor inputs. In this model, to either maintain the current size of the workforce (by replacing departing workers) or change the size of the workforce, firms advertise job openings and hire new workers each period. Changes in labor inputs are subject to stochastic adjustment costs coming from search-matching frictions in labor markets. The adjustment costs represent resources spent on hiring activities and increase convexly with the job openings rate (i.e., the ratio of the number of vacancies to the size of the workforce). The expected return for the rm is a ratio of marginal benefits to marginal costs. Accordingly, the model predicts a negative relation between the job openings rate and expected return in the subsequent period. Empirical tests con rm the model's prediction and show that the job openings rate is a strong negative predictor of returns. The job openings rate also outperforms 16 other popular forecasting variables. Forecasts obtained from the job openings rate also leads to large gains in returns for investors who consider it in making asset allocation decisions. In the second essay, I reexamine the relation between managerial activeness and mutual fund performance. Several recent studies argue that investors can use exante observable proxies of managerial activeness (e.g., active share, active weight, return gap, and R2) to predict net of fee risk adjusted performance of mutual fund managers. Using a sample 11 such managerial activeness proxies, first, I show that the predictive power of the activeness proxies is largely concentrated in a three year period from 1999 to 2001 and excluding this period, only two activeness proxies significantly predict net alpha. Second, none of the activeness proxies are significantly predictors in out-of-sample tests. Third, the characteristic-sorted portfolios formed using the activeness proxies have positive exposures to profitability and investment factors. Using the Fama and French (2015) five-factor model as the benchmark, net alpha for these portfolios reduces by about 80% on average.

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Cheaper is Not Better: On the Superior Performance of High-Fee Mutual Funds

Cited by 7 publications

References 71 publications

Actual rate of the management fee in mutual funds of different styles

Actual rate of the management fee in mutual funds of different styles

Mutual Funds’ Cost Persistence

Essays on return predictability and active management

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