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Ekonomi och samhälle
Economics and Society
Skrifter utgivna vid Svenska handelshögskolan
Publications of the Hanken School of Economics
Nr 301
David Humberto González Osorio
Essays on Mutual Fund Performance
Helsinki 2016
Essays on Mutual Fund Performance
Key words: Mutual Fund Performance
© Hanken School of Economics & David Humberto González Osorio, 2016
David Humberto González Osorio
Hanken School of Economics
Department of Finance and Statistics
P.O.Box 287, 65101 Vaasa, Finland
Hanken School of Economics
ISBN 978-952-232-310-1 (printed)
ISBN 978-952-232-311-8 (PDF)
ISSN-L 0424-7256
ISSN 0424-7256 (printed)
ISSN 2242-699X (PDF)
Juvenes Print – Suomen Yliopistopaino Oy, Tampere 2016
i
in nomine Patris, et Filii, et Spiritus Sancti.
ii
PREFACE
I would like to thank my supervisor, Professor Johan Knif for his support and guidance.
I thank Professor Kenneth Hogholm for giving me advice and direction. Thank you Johan
and Kenneth for allow me to teach and assist in several courses during my years at
Hanken. The experience I have accumulated is invaluable.
I thank the external reviewers of the Dissertation, Professor Wolfgang Bessler and
Professor Timo Rothovius. Your insightful comments help me to improve in great
manner my research.
I am especially grateful with the Department of Finance at Hanken, the Hanken
Foundation and the WCEFIR fund for supporting me financially during this quest.
I am thankful to fellow students and Professors at the Department for spending some
time reading earlier versions of the manuscripts and given valuable comments in the
internal seminars. Thanks to Mujahid, Ihsan, Annand, Hilal, Nader, Saint, Nasib,
Gbenga, Mo, Fredrik, and Jesper.
I thank my siblings, Sandra and Andrés, for their continued support and for encourage
me to not give up. Thanks to my mom for her wisdom and faith. Thanks to my late father
for inspiring me.
Thanks to Mariana and Nicolás for giving me the strength to overcome my weaknesses.
Special thanks to Rocío, my lovely wife. Thank you for believe in me. I truly appreciate
your sacrifices while you join me in this journey far from home.
Finally, thanks God for bringing me to the end of this stage in my life.
CONTENTS
FIRST PART
BACKGROUND, METHODOLOGY AND FINDINGS
1 INTRODUCTION....................................................................................... 1
2 LITERATURE OVERVIEW ...................................................................... 4
3 THE MUTUAL FUND INDUSTRY IN THE U.S. ..................................... 6
4 MUTUAL FUND PERFORMANCE AND PERSISTENCE .................... 10
5 NETWORKS IN FINANCE ...................................................................... 11
6 CENTRALITY MEASURES .....................................................................13
7 MUTUAL FUND NETWORK .................................................................. 17
8 SUMMARY OF ESSAYS ......................................................................... 24
8.1 The effect of network characteristics on mutual fund performance .................24
8.2 Performance persistence and the mutual fund network ...................................24
8.3 Empirical analysis on mutual funds herd behavior using a network approach25
REFERENCES ............................................................................................ 27
SECOND PART
THE ESSAYS
1 THE EFFECT OF NETWORK CHARACTERISTICS ON MUTUAL FUND
PERFORMANCE…………………………………………………………………………....33
2 PERFORMANCE PERSISTENCE AND THE MUTUAL FUND
NETWORK…………………………………………………………………………………….95
3 EMPIRICAL ANALYSIS ON MUTUAL FUND HERD BEHAVIOR
USING A NETWORK APPROACH………………………………………………..…127
FIRST PART
BACKGROUND, METHODOLOGY AND FINDINGS
1
1 INTRODUCTION
There is plenty of research on mutual fund performance. Various questions have been
raised and some have been answered although not all researchers concur with the
findings. The US is without hesitation the most studied market. The abundance of data
and general presumption about good data quality have helped researchers to evaluate
hypotheses about how financial markets work. Two examples are the test of the efficient
market hypothesis and the evaluation of performance in the mutual fund industry. As
Chang and Lewellen (1984) mentioned, collective performance is relevant to the efficient
market hypothesis while individual funds performance is relevant for evaluating the
performance of the mutual funds. In the literature the question of whether actively
managed mutual funds perform better than index funds has been studied extensively; if
actively managed funds charge higher fees than passive funds, an investor should expect
higher returns, net of expenses from actively managed funds. If actively managed funds
cannot outperform the market, there is no obvious reason to invest in those funds.
Solving questions regarding performance of mutual funds is not an easy task and there
is no agreement on how to measure performance. Since the early 1960s numerous
measures have been proposed; in some cases, studies have reached contradictory
conclusions, depending on the performance measurements utilized. Perhaps the most
interesting phenomenon that researchers have investigated is the existence of persistent
outperformance and therefore, whether “gifted” managers exist that can transform
stones into gold: are there alchemist fund managers that can consistently outperform the
market and create wealth at will? More to the point how we can find them? To obtain an
answer we need to know when a stone can be considered gold or just a stone. But
establishing outperformance depends on different issues, one of which is how
performance is measured. Other concerns are related to how performance is calculated.
Performance can be calculated for individual funds or portfolios. When the time horizon
varies, different results have been proved; and the results also depend on the type of
funds included in the assessment; such as dead funds, new funds, and small funds. Many
other factors can be considered too. Later in this introductory chapter, a brief review of
the previous literature helps to illustrate some of the challenges that researchers have
faced when studying mutual fund performance.
Evidence of outperformance is not necessarily explained by the existence of talented
managers. Under the assumption that all managers have equally access to the same
information, funds can outperform the market simply because of luck. The idea that
information is available for free to all participants in the market creates a paradox: why
should an investor spend money gathering information, researching, and analyzing it
when the result is not an advantage? An advantage should exist and funds with an
informational advantage should produce better returns.
Because investigating mutual fund performance is a very competitive field in financial
research, finding anything new to say is a challenge. In this dissertation, we elaborate on
some observations made by Brown and Goetzmann (1995). The authors found that on a
year-by-year basis, funds are usually consistent winners or losers but sometimes
reversals occur. According to the authors, one reason that could explain those reversals
is that “…persistence is correlated across managers. Consequently, it is likely due to a
common strategy that is not captured by standard stylistic categories or risk
2
1
adjustment procedures.” They suggested that future research should investigate “…
2
issues of cross-fund correlation…”
In that sense, to address the issue of performance in the mutual fund industry, it must
be very helpful to use a network approach based on cross-fund correlation to calculate
metrics that can help to describe the existence of common features not captured by
common factors. Even though Brown and Goetzmann (1995) were interested in the study
of mutual fund persistence, we consider it important to investigate initially how
measures of the mutual fund network are related to abnormal performance in mutual
funds. Previous studies have found that measurements of performance adjusted by risk
factors are explained by some fund characteristics, like size, age, expenses and turnover.
In the first essay of this dissertation we argue that performance is also explained by other
features of the funds related to informational linkages. Grossman (1976) showed that in
order to have incentives to collect information, traders should be able to hide it from
other traders. We argue that managers with different types of information will invest
differently. In the same line of argument, managers with access to only free public
information and poor private information should behave similarly, and their
investments should perform close to the market, while managers of the type that holds
quality private information should outperform the market. In that sense, funds with
similar type of information will be correlated. We propose that informational linkages
can be approximated by measurements of centrality in a network of mutual funds.
Centrality of a fund in the network, as explained later, can be interpreted as a measure
of how closely correlated the returns of a fund are to other funds in the market.
In the second essay we build on the foundations of the first essay to include measures of
the mutual fund network in order to establish a link between persistence and correlation
across funds. If there are informational linkages, those connections could help to test for
persistence. The reasoning is simple. Suppose that a number of funds have access to
similar private information and assume that managers will interpret that information in
the same way. Then, we expect that the returns of those funds will be correlated to each
other; if the returns of those funds were correlated by luck, it is expected that in the next
period, those linkages will disappear. However, when those linkages remain from one
period to another, we can consider that the returns of the funds are not correlated by
chance and we expect to find persistence.
Finally, we consider how correlation across funds can help to explain herd behavior in
the mutual fund industry. The third essay argues that an aggregate centrality measure in
the network of mutual funds could signal the existence of herd behavior in the market.
This dissertation specifically studies performance in the mutual fund industry utilizing a
network approach to address the following three questions. Do the characteristics of the
mutual fund network help to explain the performance of mutual funds? Is the position
of a mutual fund in the network related to persistence of abnormal performance of the
fund? Do changes in the structure of the network of mutual funds signal the presence of
herd behavior?
Individually, the essays contribute to the study of mutual funds by adding a newer
perspective to the field of finance. The three essays endorse the idea that the network of
1
Brown and Goetzmann (1995:680)
2
Brown and Goetzmann (1995:680)
3
mutual funds shaped by different frequencies contains information that certainly plays a
part in answering the questions proposed. Specific characteristics of the network of
mutual funds are related to performance, while centrality of a mutual fund is related to
persistence of abnormal performance and changes in average degree centrality signal the
presence of herd behavior.
