SECURITIES PRICE PATTERNS
VI: STUDIES OF INSTITUTIONAL PORTFOLIO PERFORMANCE
6.3 Market Timing Findings
56 Chapter VI
provide any reason to abandon the efficient market hypothesis.^"^
Following Malkiel, Gruber (1996), in "Another Puzzle: The Growth in Actively Managed Mutual Funds," uses a sample of 270 funds (1985-1994) and finds that mutual funds underperform the market by 1.94% per year. With a single index model the underperformance is 1.56%, and with a four-index model the underperformance is 0.65%) per year. Non-surviving funds underperform the market by 2.75% per year. Gruber also tests index funds and reports that they have an average annualized negative alpha of 20.2 basis points, with average expenses of 22 basis points.
In a more recent, widely-cited paper by Wermers and Moskowitz (2000), "Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transactions Costs, and Expenses," the authors decompose mutual fund retums by attributable factors such as stock holdings, expense ratios, and transaction costs. Findings indicate that annual trading costs are lower and expense ratios are higher in 1994 than in 1975.
Furthermore, mutual funds on average hold stocks that outperform a market index by roughly their combined expenses and transactions costs, but the funds' net retums are about 1% lower than the CRSP index.
Institutional Portfolio Performance 57
concave characteristic line.^^ Returns for 57 funds (1953-1962) are examined to determine if the volatility of a fund is higher in up- years than in down-years. They compute a characteristic line wherein a managed fund's return is plotted against the rate of return for a suitable market index.
The specific model used by Treynor and Mazuy to test mutual fund managers' market timing ability is stated:
(4) ^p,, =ccp+ Pprm,t + \^prit + ^p,t ^
where r^t is the excess return on a portfolio at time /, r^t is the excess return on the market, |Lip measures timing ability (if a mutual fund manager increases the portfolio's market exposure prior to a market increase, then the portfolio will be a convex function of the market's returns, and |LI will be positive). They find no evidence of curvature in any fund's characteristic lines and conclude that none of the managers outguesses the market.
A decade after Mazuy and Treynor, Miller and Gressis (1980), in "Nonstationarity and Evaluation of Mutual Fund Performance,"
address the issue of market timing. They explain that estimated fund alpha and beta may provide misleading information if nonstationarity is present in the risk-return relationship and is ignored. They examine 28 no-load funds and find that only one fund has stationary betas, while the number of betas for any given fund varies considerably over periods. Their findings indicate both weak, positive relationships and weak, negative relationships between betas and the market return, hence little evidence of timing ability.
During the ensuing years, several widely cited articles address the issues of timing and securities selection. Kon and Jen (1979) in "The Investment Performance of Mutual Funds: An Empirical
35
A model similar to the one used by Treynor and Mazuy was later developed by Henriksson and Merton (1981).
58 Chapter VI
Investigation of Timing, Selectivity and Market Efficiency,"
employ several models of market equilibrium to evaluate simultaneous market timing and stock selectivity performance.
Using a sample of 49 mutual funds with different investment objectives, they report that some funds generate superior selectivity performance but that fund managers are unable to select securities well enough to recoup research expenses, management fees, and commissions. These finding are supported by Kon (1983) in "The Market-Timing Performance of Mutual Fund Managers," who finds that a sample of funds produces better selectivity than timing performance. Like results are reported by Chang and Lewellen (1984) in "Market Timing and Mutual Fund Investment Performance," who jointly test for either superior market-timing or security-selection skills for a sample of 67 mutual funds during the 1970s, and find that managers' security selection abilities are significant in only five instances, and three of these five have negative values. Similar findings are reported for managers' market-timing abilities.
Ten years later. Person and Schadt (1996), in "Measuring Fund Strategy and Performance in Changing Economic Conditions,"
address the effects of incorporating informational variables in an attempt to better capture the performance of managed portfolios such as mutual funds. Their conditional models allow estimation of time-varying conditional betas, as managers are likely to shift their bets on the market to incorporate information about market conditions. Using 67 mutual funds over the period 1968-1990, they find that the use of conditioning information is significant. In contrast to traditional measures of performance, conditional models produce alphas that have a mean value of zero; thus there is no evidence of perverse market timing. In a similar vein. Person and Warther (1996), in "Evaluating Pund Performance in a Dynamic Market" use data for 63 funds and show that, unlike the unconditional models, funds do not usually underperform the S&P
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500 Index on a risk-adjusted basis. Soon afterward Becker, Person, Myers, and Schill (1999), in "Conditional Market Timing with Benchmark Investors," investigate the market-timing ability of mutual funds by employing models that: (1) allow the manager's payoff fimction to depend on excess retums over a benchmark, and (2) distinguish timing based on public information from timing based on superior information. Their conditional market-timing model yields no evidence of timing ability, which is more reasonable than that reported in the prior literature on market timing.
Volkman (1999), in "Market Volatility and Perverse Timing Performance of Mutual Fund Managers," investigates fixnd managers' security-selection and market-timing abilities over the 1980s, as well as performance persistence prior to and after the 1987 crash. Using data for 332 funds (1980-1990), he finds negative correlation between a fund's timing and selectivity performance and concludes that during periods of high volatility, few funds correctly anticipate market movements, although many fixnds outperform the market via security selection.