Return Horizon and Mutual Fund Performance
63 Pages Posted: 24 Mar 2020 Last revised: 30 Apr 2021
Date Written: April 29, 2021
Measures of investment performance depend on the horizon over which returns are assessed. While 47% of U.S. equity mutual fund returns exceed matched-month SPY ETF returns, only 29% of the funds outperform the SPY in terms of compound returns over the full 1991-2018 sample period. Further, alpha, the canonical measure of mean return after allowing for systematic (beta) risk, depends on return horizon, and the effect of horizon is asymmetric in beta. Compared to a benchmark of 41% estimated in monthly returns, the percentage of mutual funds with positive alpha estimates against the SPY decreases to 21% (increases to 46%) at the decade return horizon for funds with high (low) estimated monthly market betas. The fact that alphas depend on the horizon over which returns are measured calls into question both the interpretation of short-return-horizon mutual fund alphas as a gauge of fund manager skill and short-return-horizon security alphas as the basis for tests of asset-pricing models.
JEL Classification: G10; G23
Suggested Citation: Suggested Citation