Investigating Underperformance by Mutual Fund Portfolios.PDF

Investigating Underperformance by Mutual Fund Portfolios By Theodore E. Day Yi Wang Yexiao Xu ∗ School of Management The University of Texas at Dallas This version: May 2001 Abstract Underperformance by equity mutual funds has been widely documented by both the popular press and academic research. Whereas previous research has interpreted underperformance as evidence that fund managers lack the ability to pick stocks, this paper focuses on the impact of portfolio composition and excess turnover on fund performance. Using standard portfolio optimization techniques, we show that the portfolio weights for the stocks selected by fund managers are on average inefficient. Our results suggest that while fund managers may actu ally possess superior stock selection skills, substantial gains could be achieved by improving the efficiency of the allocation of mutual fund assets. In addition, we present evidence suggesting that mutual fund turnover is excessive and that fund managers may rely too heavily on stock price momentum. ∗We are grateful to Wayne Ferson, Richard Green, Burton G. Malkiel, Larry Merville, and the anonymous referees for their comments. The address of the corresponding author is: Yexiao Xu, School Of Management, The University of Texas at Dallas, PO Box 688, Richardson, Texas 75080, USA; Email: yexiaoxu@utdallas.edu i Investigating Underperformance by Mutual Fund