Investing in Mutual Funds When Returns are Predictable

Posted: 1 Jun 2005

See all articles by Doron Avramov

Doron Avramov

Interdisciplinary Center (IDC) Herzliyah

Russ Wermers

University of Maryland - Robert H. Smith School of Business; European Corporate Governance Institute (ECGI)

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Abstract

This paper analyzes the performance of portfolio strategies that invest in no-load, open-end U.S.; domestic equity mutual funds, incorporating predictability in (i) manager skills, (ii) fund risk-loadings, and (iii) benchmark returns. Predictability in manager skills is found to be the dominant source of investment profitability - long-only strategies that incorporate such predictability considerably outperform prior-documented hot-hands and smart-money strategies, and generate positive and significant performance with respect to the Fama-French and momentum benchmarks. Specifically, these strategies outperform their benchmarks by 2-4% per year through their ability to time industries over the business cycle. Moreover, they choose individual funds that outperform their industry benchmarks to achieve an additional 3-6% per year. Overall, our findings indicate that industries are important in locating outperforming mutual funds, and that active management adds much more value than documented by prior studies.

Suggested Citation

Avramov, Doron and Wermers, Russell R., Investing in Mutual Funds When Returns are Predictable. Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=733383

Doron Avramov (Contact Author)

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

HOME PAGE: http://faculty.idc.ac.il/davramov/

Russell R. Wermers

University of Maryland - Robert H. Smith School of Business ( email )

Department of Finance
College Park, MD 20742-1815
United States
301-405-0572 (Phone)
301-405-0359 (Fax)

HOME PAGE: http://www.rhsmith.umd.edu/finance/rwermers/

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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