Measuring Fund Strategy and Performance in Changing Economic Conditions

Abstract

The use of predetermined variables to represent public information and time‐variation has produced new insights about asset pricing models, but the literature on mutual fund performance has not exploited these insights. This paper advocates conditional performance evaluation in which the relevant expectations are conditioned on public information variables. We modify several classical performance measures to this end and find that the predetermined variables are both statistically and economically significant. Conditioning on public information controls for biases in traditional market timing models and makes the average performance of the mutual funds in our sample look better.

Portfolio Performance Measurement: Review of Literature and Avenues of Future Research

“…Their management activities generate more negative alphas than positive alphas. In addition, Jagannathanand and Korajczyk [12]; and Ferson and Schadt [1] used T & M and H & M models to assess passive investments strategies performance. Their findings indicate that a passive investment strategy can generate positive market timing coefficients and negative stock picking coefficients (negative Jensen's alpha).…”

“…The conditional measure (Equation (11)) proposed by Ferson and Schadt [1] assumes that beta is a linear function of predetermined public macroeconomic variables (z t−1 ) at period t − 1. In fact, using a Taylor series expansion, the portfolio beta can be written as follows:…”

“…The opposite is also true. Ferson and Schadt [1] approach takes into consideration such possibilities. In fact, the underlying intuition behind the additional term ( ) ( )…”

“…Their major shortcoming is the assumption that risk is constant over the entire evaluation period. On the other hand, conditional measures relax this hypothesis by allowing portfolios risk and market premiums to vary over time with the state of the economy (Ferson and Schadt [1]). Recent empirical findings reveal that conditional performance techniques improve investors' perception of the portfolio management industry [2].…”

On the timing of managed funds’ industry exposure

“…Bollen and Busse (2001) find some evidence of market timing ability using daily, rather than monthly, data. Ferson and Schadt (1996) use conditioning information in their models that result in an improvement in performance but no significant ability is detected.…”