FOR IMMEDIATE RELEASE: CONTACT:
George M. Tomczyk, (716) 275-8189
Nadia Bolalek, (716) 273-4806
STANDARD MEASURES OF MUTUAL FUND PERFORMANCE ARE INACCURATE
Investors May Be Taking More Risk Than They Think, New Simon School Study Shows
Rochester, N.Y. -- December 8, 1997 -- Standard, widely-used measures of mutual fund performance are inaccurate and unreliable, and can lead to faulty conclusions by investors, a new study shows. The study--conducted by Professors S. P. Kothari and Jerold B. Warner of the William E. Simon Graduate School of Business Administration and funded by the Association for Investment Management and Research--has important implications not only for fund managers who claim they can outperform the market, but also for ratings services such as Morningstar that track mutual fund performance.
Evaluating Mutual Fund Performance is the first research of its kind to empirically study the measures used to evaluate mutual fund performance. This research analyzes commonly used measures of performance like risk-reward ratios, market timing, and benchmarking by investment styles. Kothari and Warner find that it is easy to erroneously conclude that a mutual fund has abnormal (superior or inferior) performance of more than three percent per year when in fact no abnormal performance exists.
"This issue is far more serious than previously assumed by academics and professionals," said S. P. Kothari, professor of accounting at the Simon School and co-author of the study. "What our study confirms is that we should have less faith in the ratings services because performance measurement techniques are crude," Kothari said. "And, because current methods that measure and adjust for risk are flawed," Kothari continued, "consumers can be investing in funds that actually take on more risk than is apparent."
The Simon study, its authors contend, also points the finger at portfolio managers who claim they can outperform the market. "How you evaluate the performance of a mutual fund manager is a bread-and-butter kind of issue that finance academics have been looking at for decades," said Jerold B. Warner, professor of finance and former chairman of the Simon School's Ph.D. Program. "But because our study is the first to demonstrate that abnormal return factors are inaccurate--it does shed new light on claims being made by individual funds." Warner added: "While investors are currently doing so, drawing inferences from performance data about stock-picking ability of fund managers is treacherous."
"Given the enormous fluctuations in the markets recently, we believe finding ways to more accurately evaluate fund performance in the future will be an increasingly important issue to investors. Evaluating Mutual Fund Performance is an important contribution to the extensive and highly controversial evaluation literature and a first step in that direction," Warner said.
Warner is an expert in portfolio theory, capital markets and corporate finance. He is currently an editor of the Journal of Financial Economics. Kothari is an expert on models of security returns. He is an editor of the Journal of Accounting and Economics. He is visiting professor of accounting at the Massachusetts Institute of Technology for the 1997-98 academic year.
The Association for Investment Management and Research is an international, nonprofit organization of more than 28,000 investment practitioners and educators in more than 60 countries, offering services in three broad categories: Education, Professional Conduct and Ethics; and Professional Practice and Advocacy.
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The Simon School is routinely ranked among the top 25 graduate business schools by U.S. News & World Report and Business Week. With one of the most highly regarded faculties in the country, it is one of the nation's leading research facilities. The School, recognized worldwide for its leading scholarship in education, employs a distinctive approach to business education because of its flexibility, innovation, youth, size, global outlook and vision. EDITOR NOTE: Professors Kothari and Warner are available for interviews. In addition, copies of Evaluating Mutual Fund Performance (FR 97-11) are available upon request. Please call the Simon School's Office of Public Affairs at (716) 275-3736; fax: (716) 275-9331; e-mail: [email protected].
Information about the Simon School is also available on the World Wide Web at http://www.ssb.rochester.edu.
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