Measuring skill in the mutual fund industry

Abstract

Using the value that a mutual fund extracts from capital markets as the measure of skill, we find that the average mutual fund has used this skill to generate about $2 million per year. We document large cross-sectional differences in skill that persist for as long as 10 years. We further document that investors recognize this skill and reward it by investing more capital with better funds. Better funds earn higher aggregate fees, and there is a strong positive correlation between current compensation and future performance. We also demonstrate why traditional measures such as the gross and net alpha fail to measure managerial skill which explains why past studies that use those measures have failed to find evidence of this skill. * We could not have conducted this research without the help of the following research assistants to whom we are grateful:

Assessing Asset Pricing Models Using Revealed Preference

“…Berk and van Binsbergen (2013) verify this fact. They demonstrate that such skill exists and is highly persistent.…”

“…where R V it is the cumulative return to investors of the appropriate Vanguard benchmark fund as defined in Berk and van Binsbergen (2013) over the horizon from t − T to t.…”

Aspects of manager, portfolio allocation, and fund performance in Brazil

“…In addition, the investment fund industry can be seen as an exception to the economic principle that nancial agents derive income from having a competitive advantage, since fund managers are among the best paid professionals in society; however, there is still a knowledge gap regarding whether they have the ability to manage money or not (Berk & Van Binsbergen, 2015). In fact, in the nancial markets of Greece, Poland, and India, no evidence has been found of any greater ability to deliver excess returns to investors (Filippas & Psoma, 2001;Sharma & Paul, 2015;Swinkels & Rzezniczak, 2009).…”

Sharpening the Arithmetic of Active Management

“…Hence, passive investors must rebalance their portfolio allocation over time as their risk preferences change and as the market's risk-return profile changes-and for other reasons as well. Indeed, they must initially buy their portfolio and will eventually need to sell it, as discussed in Berk and van Binsbergen (2015). Along the way, they need to decide whether to reinvest dividends or sell some fraction of their portfolio to pay for a new house, a car, or other expenses.…”

“…Depending on the sample and benchmark, active mutual funds have on average performed similarly to the market before fees and underperformed after fees (Fama and French 2010) or have outperformed before fees and performed similarly to the market after fees (Berk and van Binsbergen 2015). Hence, active mutual fund fees have been so large on average that they have consumed all or more than the managers' alpha, so the average retail investor would have been well served by following Sharpe's advice to use low-cost, passive investing.…”