Analyzing Mutual Fund Performance Against Established Performance Benchmarks: A Test of Market Efficiency

Document Type

Article

Publication Date

2010

Abstract

The efficient market hypothesis maintains that active investment management is pointless. Rather, an investor is better off deploying a passive investment strategy by utilizing a market index alternative. However, the existence of a significant mutual fund industry illustrates a belief to the contrary. This paper analyzes the small cap growth stock sector of the mutual fund industry against risk-free and market returns over the ten years 1997-2006. Results are tested against a toolkit of performance benchmarks to see if expected performance closely corresponds to the actual results. Development of various performance benchmarks has allowed investors to quantitatively assess various portfolio alternatives and has established that diversification can reduce systematic risk. Mutual funds are a way for most investors to achieve these results without the need for expensive research and excessive trading costs. The results indicate that some excess returns have been generated; however, beyond a handful of the funds, it is impossible to rely upon a single benchmark as a reliable indicator of even past performance. A “portfolio approach” of combining the benchmarks does not seem to work any better. The evidence tends to support market efficiency since for the most part, the actively managed funds examined in this study produced returns that were largely expected.

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