Practical Applications of Mutual Fund Returns and Their Characteristics: A Simple Approach to Selecting Better-Performing Actively Managed Funds

Abstract

In Mutual Fund Returns and their Characteristics: A Simple Approach to Selecting Better-Performing Actively Managed Funds, from the April 2020 edition of The Journal of Investing, Burton G. Malkiel of Princeton University and Atanu Saha of Econ One Research discuss which mutual-fund attributes best predict future fund returns. The authors find that fund selection guided by a combination of characteristics—low turnover rates, low expense ratios, and high Sharpe ratios—can lead to portfolios that considerably outperform the average actively managed fund.

The authors use a robust dataset comprising prices on US and international equity funds from 2000 to 2018. They investigate the persistence of fund attributes—fund age, size, net asset flows, prior-year returns, turnover rates, Sharpe ratios and expense ratios—in auguring future returns, both year-over-year and longer term. While verifying that expense ratios are significant predictors of a fund’s future returns, they stress that Sharpe ratios and turnover rates are even more predictive. Investors are encouraged to apply all three traits together to build better-performing fund portfolios. Moreover, these cost and risk-control characteristics persist enough to enable investors to dependably detect funds with extended, and statistically significant, above-average returns.

TOPICS: Portfolio theory, portfolio construction, style investing