Yale School of Management Financial Tool Identifies High-Performing Mutual Funds
New Haven, CT, April 21, 2003 - In the midst of the worst mutual fund performance in a decade, a Yale School of Management research team proposes a new financial model to identify mutual funds that will substantially outperform the market benchmark.
The study, "Estimating the Dynamics of Mutual Fund Alphas and Betas," was written by Assistant Professor of Finance Harry Mamaysky, Professor Matthew Spiegel and Hong Zhang, a doctoral fellow with the Yale School of Management's International Center for Finance. The research includes an online table that ranks mutual funds in terms of predicted performance adjusted for risk.
The fast-growing mutual fund industry continues to attract attention from analysts who hope to differentiate fund managers whose portfolios produce high returns due to skill from those whose portfolios simply mirror the market. "Before concluding that a manager's returns reflect an ability to pick 'good' stocks, it is necessary to properly adjust for the portfolio's riskiness," the Yale School of Management authors explain.
In part, a portfolio's risk depends on how it moves with the overall market: The team devised a method that potentially produces more accurate risk and performance estimates than other tools now in use. Traditional forecasting tools pose statistical problems when applied to overall portfolio returns. That is, models that accurately describe returns of individual securities may misrepresent a total portfolio holding those same securities.
The Yale School of Management model mitigates such estimation problems by allowing for variation in the fund's portfolio holdings over time. Of note, the model does not depend on direct details of either the portfolio manager's exact investment strategy nor the specific risks of the portfolio's individual holdings. Nevertheless, the model can accommodate active trading on the part of fund managers.
The team designed the model and then ran numerous simulations in which they constructed portfolios using both the new dynamic model and traditional methods. Generally, the selections of the Yale School of Management model yield 1.5% more per annum than the selections from the traditional method, according to Professor Spiegel. The Yale School of Management model successfully tracked dynamic measurements for mutual funds - dominating the traditional method in estimating portfolio return parameters.
A table containing fund performance predictions based on data through April 2003 can be found on Professor Spiegel's web page. Professor Spiegel cautions that the table's rankings maintain accuracy for about three to six months. The team intends to update the table every three months, but does not endorse any particular mutual fund.
Dr. Spiegel is co-editor of the Journal of Financial Markets and Professor of Finance at the Yale School of Management. Dr. Mamaysky, an Assistant Professor of Finance, is currently on leave from Yale, and is a vice president in a proprietary trading group at Morgan Stanley.