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Minimizing Risk in the Ghanaian Banking Sector

In: Business and Management

Submitted By KwasiAmpah
Words 25395
Pages 102
Investing in Mutual Funds when Returns are Predictable

DORON AVRAMOV AND RUSS WERMERS*

First draft: May 26, 2004 This Revision: April 21, 2005

*Doron Avramov is from the University of Maryland, e.mail:davramov@rhsmith.umd.edu, Tel: 301405-0400, and Russ Wermers is from the University of Maryland, e.mail: rwermers@rhsmith.umd.edu, Tel: 301-405-0572. We thank seminar participants at Copenhagen Business School, George Washington University, Inquire-UK and Inquire-Europe Joint Spring Conference, Institute for Advanced Studies (Vienna), Stockholm Institute for Financial Research (SIFR), Tel Aviv University, University of Manitoba, University of Toronto, Washington University at St. Louis, and especially an anonymous referee, for useful comments. All errors are ours.

Investing in Mutual Funds when Returns are Predictable

Abstract This paper analyzes the performance of portfolio strategies that invest in noload, open-end U.S. domestic equity mutual funds, incorporating predictability in (i) manager skills, (ii) fund risk-loadings, and (iii) benchmark returns. Predictability in manager skills is found to be the dominant source of investment profitability – long-only strategies that incorporate such predictability considerably outperform prior-documented “hot-hands” and “smart-money” strategies, and generate positive and significant performance with respect to the Fama-French and momentum benchmarks. Specifically, these strategies outperform their benchmarks by 2-4% per year through their ability to time industries over the business cycle. Moreover, they choose individual funds that outperform their industry benchmarks to achieve an additional 3-6% per year. Overall, our findings indicate that industries are important in locating outperforming mutual funds, and that active management adds much more value than documented by prior studies.

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