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Posted on March 8th, 2013, by

The emergence of mutual funds and the growing attention to them from the part of investors raise the problem of defining factors contributing to the successful performance of mutual funds. In this regard, professional skills of fund managers and luck are considered to be the major factors contributing to the success of mutual funds. The study reveals the fact that traditional tests lead to quite controversial conclusions for they reveal the fact that both professional skills and luck may be important for the successful performance of mutual funds.

However, in terms of the current study, the CAPM and ANOVA were applied to test the impact of professional skills and luck of fund managers on the performance of mutual funds. The study has revealed the fact that professional skills of fund managers are prior to luck in regard to the successful marketing performance of mutual funds.

Table of contents:
1. Introduction
2. Literature review the performance of mutual funds
2.1 Measuring forecasting ability of mutual funds’ managers
2.2 Limitations to the traditional methods
2.3 Skill vs. luck in the performance of mutual funds’ managers
3. The Capital Asset Pricing Model as a framework to performance measures
3.1 The CAPM logic
3.2 The testing approach of the CAPM
3.3 Empirical evidence and limitations of the CAPM
4. Empirical tests and interpretation
4.1 The data
4.2 Test procedure
4.3 Results and interpretation of the test
5. Conclusion
6. References

 

 

 

1. Introduction

Today, the emergence of mutual funds contributes to the fast development of business and investments but the performance of mutual funds often depends on professional skills and abilities of their managers to perform successfully and to manage funds effectively. In this regard, specialists (Scholz, 2006) argue that the overall performance of mutual funds may depend not only on the professional skills and abilities of their managers but also on the mere luck. What is meant here is the fact that the successful performance of mutual funds is often explained by mere luck but not by professional skills and abilities of their managers. Obviously, the luck seems to be prior to skills and abilities of mutual funds’ managers because of substantial difficulties associated with forecasting of the development of financial markets.

In such a situation, the ability and skills of managers related to forecasting the market development may be explained by mere luck, whereas, in actuality, managers often forecast the further development of the market and are capable to invest funds successfully to maximize revenues of investors of mutual funds. Nevertheless, the question concerning the priority of skills over luck and, vice versa, luck over skills of mutual funds’ managers persists and needs the definite answer, which is possible to obtain on the ground of statistical analysis.

In this respect, it is possible to suggest a hypothesis that the performance of mutual funds depends primarily on their managers’ skills and abilities to forecast the market and business development accurately, whereas luck is secondary and rather abstract than concrete concept.

2. Literature review the performance of mutual funds

2.1 Measuring forecasting ability of mutual funds’ managers

On analyzing the role of fund managers in the development and maintenance of mutual funds, it is possible to refer to different studies and statistic analysis conducted by different specialists, who researched the problem of the impact of managers’ skills on the performance of mutual funds. At any rate, existing studies (Leger, 1997) show that the problem of the revelation of correlation between managers’ skills and mere luck is quite difficult to define. To put it more precisely, specialists (Sharpe, 1994) consider mutual funds being dependent on both skills and luck, whereas the debate over the role of luck in the overall success of mutual funds persist. In fact, the problem of the distinguishing the impact of managerial skills and luck on the performance of mutual funds is difficult because the development of markets is often chaotic and difficult to forecast. In such a situation, experts tend to take into consideration luck as an integral part of the contemporary business development and mutual funds’ performance. Hence, specialists (Jensen, 1968) argue that the mutual funds’ performance may be dependent on luck but not skills of their managers.

However, this view of mutual funds and their managers’ work seem to be superficial because managers working in mutual funds conduct the detailed analysis of markets and manage funds on the ground of their experience, expertise, forecasts, and, naturally, their professional skills and abilities. To put it in simple words, this means that managers working in mutual funds use their skills to manage funds effectively.

They take decisions on the ground of the detailed analysis but not on the ground of their intuition solely. Therefore, their success is not the result of their luck but, in contrast, the result of their hard work and their professional skills. Otherwise, mutual funds would not need managers at all. Instead, they could employ ad hoc employees, who could perform the work of fund managers and rely on luck solely to reach the same results as professional fund managers do.

At this point, it is possible to refer to studies conducted by Jensen. On the ground of the Jensen’s Alpha, it is possible to make a conclusion that professional skills and abilities of fund managers are prior to luck and they play the key part in the overall performance of mutual funds. In fact, tests grounded on the Jensen’s Alpha reveal the fact that managers’ skills define, to a significant extent, the performance of mutual funds. In fact, the qualification of mangers can be a determinant factor in the marketing success of mutual funds. At this point, it is worth mentioning the fact that the high qualification of professional fund managers contributes to the steady and successful development of mutual funds, whereas many newcomers or inexperienced fund managers failed because they failed to have extensive experience and their qualification was low. Moreover, they rely too much on luck and pay little attention to accurate analysis and forecasting of the market development. As a result, they fail. In stark contrast, experienced managers with well-developed managerial skills, who have been working in mutual funds for years, rely on their experience and skills mainly. These managers use the full potential of their professional skills and abilities to manage mutual funds effectively. They conduct the detailed analysis of the market and take decisions on the ground of analysis and forecast they have concerning the further market development. They do not rely on mere luck as some of their less experienced colleagues do and they reach consistently greater success in their work, whereas mutual funds employing such managers demonstrate the positive marketing performance and steady business development.

At the same time, the Treynor and Mazuy’s measure of market ability reveals the fact that luck cannot be totally denied, when the mutual funds’ performance is under consideration. In fact, the tests conducted on the ground of Treynor and Mazuy’s measure of market ability have revealed the fact that markets are vulnerable to consistent changes under the impact of multiple factors. Hence, many researchers (Leger, 1997) conclude that luck is extremely important for successful work of fund managers, whereas their professional skills may be secondary to luck. This conclusion is grounded on the premise that managers cannot forecast accurately all the changes that may occur in markets, whereas markets have the ability to change fast and unexpectedly. Hence, researchers using Treynor and Mazuy’s measure of market ability tend to conclude that fund managers depend on luck and their performance is also dependent on luck (Scholz, 2006). As a result, they conclude that the performance of mutual funds is dependent on luck but not professionals skills of fund managers. At any rate, such studies arrive to the idea that professional skills of fund managers are secondary and inferior to luck, which plays the primary part in the success of mutual funds.

Another traditional tool to measure the contribution of fund managers’ skills and luck in the overall success of mutual funds is grounded on the Henriksson and Merton’s test of market timing ability. Studies based on this test (Modigliani & Modigliani, 1997) place emphasis on the fact that managers’ skills may play a determinant part in the mutual funds’ performance because markets are vulnerable to changes but managers should be capable to take decisions fast within a limited time framework. This is why fund managers cannot rely on mere luck solely. Instead, they should be able to use all their skills and abilities to take decisions fast and to respond to changes in the business environment and in the market as soon as possible. In such a way, fund managers can reach a tremendous success and lead their funds to positive marketing performance. Otherwise, according to studies based on the Henriksson and Merton’s test, mutual funds cannot perform steadily and successfully (Scholz, 2006). In fact, they may reach provisional successes but they cannot develop steadily and successfully in a long-run perspective because the steady and successful development of mutual funds is impossible without the high qualification of fund managers and their skills and abilities to forecast market development and to take fast and effective decisions. Therefore, fund managers should have extensive professional skills and abilities, which contribute to the successful development of mutual funds.

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