Mutual Fund Performance Persistence: Still True?

PURPOSE The purpose of this paper is to examine the performance persistence of a large sample of mutual funds over time. Specifically do mutual fund managers show positive (negative) performance year after year? Alternatively, is mutual fund performance from one year to the next basically a random event? It's been many years since mutual fund performance persistence has been examined. This paper will examine whether persistence is still valid in mutual fund investing. MOTIVATION A number of researchers have examined mutual fund performance persistence, but the results are still inconclusive. Grinblatt and Titman (1992) find that there is positive persistence in mutual fund performance. They find that part of the persistence is due to differences in fees and transaction costs across funds. They conclude that past performance does provide useful information for investors. Hendricks, Patel, and Zeckhauser (1993) find that the relative performance of growth, no-load mutual funds persists in the short-term, with the strongest results for the one-year horizon. Poor performing funds show significantly worse performance over time, although the better performing funds don't show significant results. Carhart (1997) shows that common factors and investment expenses almost totally explain persistence in equity mutual funds. He indicates that "hot hands" is explained by the one-year momentum effect of Jegadeesh and Titman (1993). Carhart agrees that the only significant persistence not explained by his common factors is the underperformance of the lowest performing mutual funds. His results do not support the existence of skilled mutual fund managers. Bollen and Busse (2005) show results that differ somewhat from Carhart. They demonstrate positive short-term performance persistence, from quarter to quarter. But, as with Carhart, the positive performance persistence disappears for longer investment horizons. They conclude that after considering transaction costs and taxes, investors may generate superior returns through a naive buyand-hold strategy over following a performance chasing strategy. Brown and Goetzmann (1995) find that funds in the bottom octile show significant negative persistence, while funds in the top octile show non-significant positive performance persistence. They show that poor performance holds over time, although positive performance is dependent on the time period studied. They hypothesize that the positive performance is due to specific macroeconomic factors over time. Eser (2008) examines shortcomings in the persistence literature. He finds that much of Carhart's (1997) persistence is due to calendar-related distortions and the use of a short-term momentum factor model. After using a longer-term momentum factor model and masking calendar year-end noise, Eser finds that performance persistence seems to disappear. Malkiel (1996) notes that over the past 25 years, about 70% of active equity managers have been outperformed by the S&P 500 Stock Index. Gruber (1996) and Bogle (1995) also note similar results. They argue that index funds allow investors to buy securities of many different types with minimal expense and significant tax savings. Bogle (1996) states that "the case for selecting an index fund is compelling due to indexing's inherent cost advantage. " Malkiel (1995) concludes by stating that "most investors would be considerably better off by purchasing a low expense index fund than by trying to select an active fund manager who appears to possess a hot hand". While the literature appeared to support performance persistence in the past, it seems the results are mixed. Our study is intended to extend the previous research by examining a larger sample of mutual funds over a more recent and longer time period. Our sample includes nine mutual fund classification categories over a ten-year investment horizon. HYPOTHESIS This study will test the hypothesis that actively managed mutual funds show significant performance persistence over our study period, 1996 through 2005. …