Geysburg Economic Review Volume 1 Aricle 4 2006 Efficiency of he Muual Fund Indusry: an Examinaion of U.S. Domesic Equiy Funds: 1995-2004 Chase J. Sewar Geysburg College Class of 2006 Follow his and addiional works a: hp://cupola.geysburg.edu/ger Par of he Behavioral Economics Commons, Economerics Commons, and he Growh and Developmen Commons Share feedback abou he accessibiliy of his iem. Sewar, Chase J. (2006) "Efficiency of he Muual Fund Indusry: an Examinaion of U.S. Domesic Equiy Funds: 1995-2004," Geysburg Economic Review: Vol. 1, Aricle 4. Available a: hp://cupola.geysburg.edu/ger/vol1/iss1/4 This open access aricle is brough o you by The Cupola: Scholarship a Geysburg College. I has been acceped for inclusion by an auhorized adminisraor of The Cupola. For more informaion, please conac cupola@geysburg.edu.
Efficiency of he Muual Fund Indusry: an Examinaion of U.S. Domesic Equiy Funds: 1995-2004 Absrac Invesors have he abiliy o choose beween wo differen managemen syles in he muual fund indusry. These wo managemen syles differ in boh he invesmen sraegy ype he fund execues and managemen coss, which are charged o he funds invesors. Firs, invesors may inves heir funds in index funds, which employ a passive invesmen sraegy. Here, invesors expec o earn a rae of reurn equivalen o he marke index minus a small managemen fee which he fund seeks o rack. Alernaively, invesors may choose acive fund managemen. The reurns of hese muual funds rely on sock selecion abiliy of porfolio managers. Acive porfolio managers perform securiies research and obain informaion in an aemp o disinguish beween undervalued and overvalued securiies allowing hem o ouperform he marke. To compensae for he cos of his research, hese funds generally charge a higher managemen fee which is paid by individual muual fund invesors. In 2004, he average acively managed fund expense raio was approximaely 140 basis poins, while he majoriy of index funds charge fees ranging from 10 basis poins o 50 basis poins. A expense raio of 140 basis poins would mean ha $140 of every $10,000 invesed by an individual in a fund will go o he porfolio manager in order o compensae hem for heir research and managemen. Some funds carry furher expenses in he form of load charges. They ake a percenage of an invesors iniial invesmen as a sales commission, as hese funds are disribued direcly by he fund managemen company. Much debae wihin he invesmen communiy has revolved around he quesion of wheher he fees charged by acively managed muual funds are jusified wih higher reurns. [excerp] Keywords Muual fund, equiy fund, invesmen reurns, invesmen sraegy, invesmen porfolio, sock marke This aricle is available in Geysburg Economic Review: hp://cupola.geysburg.edu/ger/vol1/iss1/4
Efficiency of he Muual Fund Indusry: an Examinaion of U.S. Domesic Equiy Funds: 1995-2004 By Chase Sewar I. INTRODUCTION Invesors have he abiliy o choose beween wo differen managemen syles in he muual fund indusry. These wo managemen syles differ in boh he invesmen sraegy ype he fund execues and managemen coss, which are charged o he funds invesors. Firs, invesors may inves heir funds in index funds, which employ a passive invesmen sraegy. Here, invesors expec o earn a rae of reurn equivalen o he marke index minus a small managemen fee which he fund seeks o rack. Alernaively, invesors may choose acive fund managemen. The reurns of hese muual funds rely on sock selecion abiliy of porfolio managers. Acive porfolio managers perform securiies research and obain informaion in an aemp o disinguish beween undervalued and overvalued securiies allowing hem o ouperform he marke. To compensae for he cos of his research, hese funds generally charge a higher managemen fee which is paid by individual muual fund invesors. In 2004, he average acively managed fund expense raio was approximaely 140 basis poins, while he majoriy of index funds charge fees ranging from 10 basis poins o 50 basis poins. A expense raio of 140 basis poins would mean ha $140 of every $10,000 invesed by an individual in a fund will go o he porfolio manager in order o compensae hem for heir research and managemen. Some funds carry furher expenses in he form of load charges. They ake a percenage of an invesors iniial invesmen as a sales commission, as hese funds are disribued direcly by he fund managemen company. Much debae wihin he invesmen communiy has revolved around he quesion of wheher he fees charged by acively managed muual funds are jusified wih higher reurns. In a model where informaion is cosly o obain and use during he sock selecion and marke iming process, i is efficien for rades made by informed invesors o compensae hem for heir research [Grossman and Sigliz,1980]. Thus, i should be found ha acive muual fund managers will provide invesors 33
wih reurns higher han ha of heir index fund counerpars offseing he higher fees paid for heir managemen. And, in equilibrium, managemen fees will be exacly equal o he cos born by managemen o obain rading informaion. This ype of model can be conrased wih a siuaion in which sock informaion is free. In his siuaion, Fama [1970] saes ha securiy prices will incorporae all available informaion. Under his form of he Efficien Markes Hypohesis (EMH), invesors would be irraional o inves in acive funds, as efficiency in he marke would make i impossible for hem o ouperform passive index funds. In effec, invesors would be paying porfolio managers o gaher informaion already imbedded in he marke. I will be he main focus of his paper o es for marke efficiency in he muual fund indusry under he condiions of cosly informaion. The paper will firs begin wih an overview of he Capial Asse Pricing Model (CAPM) and he Sharpe Raio and review relevan sudies on muual fund performance. Nex, he CAPM and he Sharpe Raio will be esimaed for he funds in our sample and compared o he overall marke. From his analysis, i will be evaluaed wheher acive equiy funds on average have had he abiliy o bea he marke over he period 1995-2004. This will be followed by a furher analysis of indusry cos efficiency updaing previous sudies by esing he effec of managemen fees and load charges on fund reurns wih he mos recenly available daa. This analysis will be used o es for inefficiencies in our chosen model of marke efficiency. Las, he findings of his research will be summarized, and concluding saemens regarding is implicaions for raional invesors will be made. II. Porfolio Theory and Lieraure Review The beginnings of modern porfolio heory came abou in he early 1960s. The following secion will review wo models of porfolio reurns ha have been developed since ha ime. In addiion, relevan sudies on porfolio reurns will be examined. A. The Capial Asse Pricing Model and he Sharpe Raio The Capial Asse Pricing Model (CAPM) was developed by Sharpe [1964] and ohers over he course of he 1960s. This model explains porfolio and securiy reurns wih he following equaion: E( R ) = RFR + b( R RFR) i M 34
Here, a porfolio s or securiy s expeced reurn is equal o he reurn of he risk free rae (RFR) and is correlaion wih he reurn of he marke (RM) defined by is Bea. The CAPM assumes ha no oher facors affec a porfolio s expeced reurn hus he CAPM expecs no abnormal reurn. Typically, he CAPM in used in empirical research in he following form developed by Jensen [1968]: R RFR = a + b ( RM RFR ) The consan erm is ofen referred o as Jensen s Alpha. Alpha is he measure of abnormal reurn in his form of he CAPM equaion (again, expeced o be zero). Jensen [1968] found, using daa on all muual funds from 1945-1964, ha he mean alpha of funds was negaive leading him o conclude ha he majoriy of muual funds could no on average bea he marke. However, Ippolio [1989] found conradicing evidence, as he mean alpha for funds in his sudy was posiive leading him o conclude ha i was possible for a random selecion of funds o ouperform he marke. In addiion, Ippolio [1989] used regression analysis o furher suppor his findings, finding ha expenses did no have a saisically significan relaionship wih fund reurns. Using he same ime period and mehodology, Elon e al. [1993] found conradicory findings o ha of Ippolio when adding a proxy variable for non-s&p500 socks ino he model. The firs secion of his paper will updae hese previous sudies wih daa on all domesic muual funds (ex-specialy funds) over he en year period 1995-2004. Boh he CAPM equaion and he Sharpe Raio of risk-adjused reurns will be used o es wheher acive funds have he abiliy o ouperform he marke. While very similar, Jensen s alpha and he Sharpe Raio differ in heir definiion of risk. The CAPM equaion defines risk as volailiy from he marke porfolio sysemaic risk. On he oher hand, he Sharpe Raio uses a porfolio s sandard deviaion as is proxy for risk, which measures oal risk. The Sharpe Raio is defined by he equaion: R RFR SR = s The numeraor is he average porfolio reurn in period minus he average riskfree rae of reurn over period. The denominaor of he equaion is he sandard deviaion of hose reurns resuling in a composie measure of porfolio performance indicaing he risk premium earned per uni of oal risk. By comparing he Sharpe Raio of a fund o ha of he marke porfolio, one can gauge he superioriy or inferioriy of ha fund s reurns [Reilly and Brown, 2003]. 35
B. The Role of Coss in Muual Fund Performance Previous sudies have found conradicory evidence in regards o he role of managemen fees on fund performance. Early sudies by Friend e al. [1970], Jensen [1968], and Sharpe [1966] all found ha muual funds do no earn raes of reurn high enough o offse heir expenses. More recenly, Bogle [1998] found similar resuls by esing over a en year period ending in 2001 and a five year period ending in 1997. In our model of efficiency, hese resuls would lead us o assume ha he muual fund indusry is no in equilibrium. Oher sudies, however, have found ha funds do achieve reurns ha are sufficien enough o offse heir coss. As discussed above, he mos noable of hese sudies was done by Ippolio [1989]. Like he work of Ippolio, he main focus of his paper will be o updae previous sudies and es for marke efficiency in he muual fund indusry using CAPM mehodology. In addiion, he Sharpe Raio will be used o furher examine he naure of reurns and coss in he muual fund indusry. III. Analysis of Risk-Adjused Reurns A. Sample Selecion The sample used hroughou his paper includes all U.S. domesic equiy funds (ex-specialy funds). All hisorical daa was obained from he Morningsar, Inc. Premium Muual Fund Screener, which holds up o en years of hisorical daa for currenly exising funds. As wih Jensen [1968], his sample suffers from survivorship bias, as only funds sill exising currenly are available o be seleced in he sample. To mee he sample selecion crieria, a fund had o have en years of available hisorical daa. In addiion, all index funds and insiuional funds were removed from he sample. Using he selecion crieria, 962 funds were included in he sample. Informaion on reurns, expense raios, and load fees were all obained from he Morningsar, Inc. Premium Muual Fund Screener daabase. Oher variables used in his secion and hose ha follow are derived or calculaed from his daa. B. Jensen s Alpha, 1995-2004 For each fund in he sample se, Jensen s form of he CAPM equaion was esimaed: (1) R RFR = a + b( R RFR ) + e, = 1995-2004, M 36
where R is he rae of reurn for he fund in year. This reurn is ne of all managemen fees excep load charges. The variable RFR is he risk-free rae of reurn in year, as measured by he reurn of U.S. Treasury Bills [Damodaran, 2005]. The rae of reurn in year of he marke porfolio, defined here as he S&P 500, is denoed R M [Damodaran, 2005]. Remember ha he CAPM has an E[α] = 0; however, superior porfolio managers who have marke iming abiliy or can consisenly selec undervalued securiies will earn higher risk premiums han he CAPM predics. In erms of he regression, superior porfolio managers will have consisenly posiive random error erms resuling in a posiive consan erm, or alpha. Consisen inferior performance in urn would lead o a negaive alpha [Reilly and Brown, 2003]. Based on he 95 percen level of confidence, i was found ha of he 962 muual funds analyzed, 905 were characerized by alphas saisically indisinguishable from zero, 12 by saisically significan posiive alphas, and 45 by saisically significan negaive alphas. These resuls are summarized in TABLE I wih he findings of Jensen [1968] and Ippolio [1989]. The mean alpha for he sample was -0.17 percen, indicaing ha he funds in he sample, on average, had inferior performance compared o he overall marke. These resuls were similar o hose found by Jensen [1968]. TABLE I Alphas for U.S. Domesic Equiy Funds Zero a Posiive Negaive Toal Mean Mean Alpha Bea Curren Sudy, 1995-2004 905 12 45 962-0.17 0.83 Ippolio, 1965-1984 127 12 4 143 0.81 0.88 Jensen, 1945-1964 b 98 3 14 115-1.1 0.84 a. Alphas are classified as zero if he absolue -values of he esimaed alpha coefficiens are less han 2.306, which enails he 95% confidence inerval, wo-ail es b. Fify-six funds in he Jensen sudy were based on annual daa from 1945-1964; he remaining resuls were based on annual daa from 1955-1964 FIGURE I Curren Sudy, 1995-2004 Ippolio, 1965-1984 Jensen, 1945-1964 posiive 1% negaive 5% posiive 8% negaive 3% negaive 12% posiive 3% zero 94% 37 zero 89% zero 85%
C. Sharpe Raio, 1995-2004 Similar o he secion above, a Sharpe Raio was calculaed for each of he 962 funds in he sample. The Geomeric Sharpe Raio, denoed in he following equaion, was used: (2) R RFR SR =, = en year period ending Dec. 31, 2004, s where < 1985 is he compound annual growh rae (CAGR), or geomeric rae of reurn, for each muual fund from 1995-2004; and RFR is he CAGR for U.S. reasury bills over he same period. The variable σ is he geomeric sandard deviaion of fund reurns over he en year period. The resuls on his analysis are found in Table II. The Sharpe Raio for he marke (S&P 500 index), is approximaely 0.21. Under porfolio heory, his figure represens he risk-adjused reurn falling on he Capial Marke Line [Reilly and Brown, 2003]. Thus, a fund wih a higher Sharpe Raio would have earned a risk-adjused reurn in excess of he marke. For he 962 funds, only 384 were able o earn reurns above he Capial Marke Line. This represens approximaely 40 percen of he muual funds in he sample. The mean Sharpe Raio was 0.17654, approximaely 0.035 below he reurn obained by he S&P 500 marke index. This resul is similar o ha found using Jensen s alpha revealing ha he funds in he sample failed o bea he marke on risk-adjused erms. TABLE II Sharpe Raio for U.S. Domesic Equiy Funds Sharpe Raio of Funds Funds Mean S&P 500 Ouperforming Underperforming Toal Sharpe Raio Curren Sudy, 1995-2004 0.2109878 384 578 962 0.17654 IV. Cos Efficiency of U.S. Domesic Equiy Muual Funds A. Model of Muual Fund Cos Efficiency In he model of efficiency esed in his paper, coss play he cenral role. Under forms of he Efficien Markes Hypohesis (EMH) where securiy prices reflec all available informaion, here is no possible way for informed (acive) porfolio managers o ouperform he marke. Thus, invesors placing heir savings in acively managed muual funds are playing a loser s game, as hey are 38
paying fees o reimburse muual fund managers for collecing and rading on informaion ha is already refleced in marke prices. Ippolio [1989] assers ha his ype of marke equilibrium is flawed. If informaion is cosly o obain and implemen, hen equilibrium, in which securiies reflec all informaion, makes i impossible for he marke o compensae for informaion-gahering aciviies. Thus, if he muual fund indusry is occupied by raional invesors, acive funds would evenually cease o exis as invesors would recognize his impossibiliy. Insead of assuming ha he exisence of acive funds is irraional, we assume a differen model of efficiency in he muual fund indusry which is used by Ippolio [1989]. In his model, Ippolio [1989] supposes ha here are a cerain number of informed raders ha are able o generae a wedge beween rade prices and full-informaion prices by gahering informaion. In equilibrium, passive invesors essenially pay informed raders a sufficien amoun o compensae for he marke arbirage funcion [Grossman, 1976]. Thus, informed raders bea he marke before expenses, bu make no excess reurns afer neing ou he coss borne during he informaion-gahering aciviy (if his were no he case and informed raders bea he marke afer neing ou expenses, i would pay for more invesors o become informed). So, in equilibrium, here is no incenive o favor an acively managed fund or a passively managed index fund. To es his model of efficiency, OLS mehodology will be used o examine wheher expense raios and load fees have any impac on he risk-adjused rae of reurn earned by all funds in he sample. B. Specificaion As wih our earlier analysis, boh Jensen s CAPM equaion and he Geomeric Sharpe Raio will be used. For he CAPM, he following OLS equaions will be used: (3) R RFR = bb i ( RM RFR ) + cei + dli + emfi + fy + e, = 1995-2004 where β i is he fund bea esimaed from equaion one. Thus, coefficien of his variable should be saisically insignifican from one. The variable E i denoes he fund s expense raio as of Dec 31, 2004; and L i is a dummy variable indicaing wheher a muual fund charges a load fee. I should be noed ha his regression uses panel daa derived from our original sample. Thus, each fund has en observaions, one for each year of he sample period. The variables MF i and Y are vecors of muual fund and year dummies. These vecors are used o accoun for correlaions beween he 39
residual across funds and years [Ippolio, 1989]. Due o consrains of our esimaion capabiliies of our available saisical sofware, he sample size had o be reduced. A random sampling of 750 funds was seleced from he original 962. I is assumed ha his sampling has lile o no effec on he empirical resuls of he regression analysis. Similar regressions are run using he Geomeric Sharpe Raio. The reurn measure used in he equaion is he raio of he fund minus ha of he S&P 500 index: (4) SR SRS& P500, = a + bei + cli + e, = 1995-2004 The enire sample of 962 funds was used for his regression. The resuls of boh regressions are shown in TABLE III and TABLE IV. D. Empirical Resuls of Cos Efficiency The resuls from he OLS regressions indicae ha muual funds are no cos efficien as he heoreical model suggess. For cos efficiency o hold, one would expec he coefficiens on he expense raio variable in he regressions o be insignifican from zero; however, his only held rue using equaion 5. In all oher insances, here was a srong negaive relaionship beween a fund s expense raio and is reurn. The esimaed coefficiens on he expense variable sugges ha for each uni increase in Ei, he fund s reurn decreased anywhere from 0.86 o 2.5 percen from is expeced value in he CAPM. TABLE III Effec of Expenses and Load fees on Performance [R -RFR ], 1995-2004 Variable Mean (3) β [R M -RFR ] 8.159 1.00 (41.03) Expense Raio 1.420-1.65 (-4.08) Load a 0.405 10.33 (2.40) Muual fund and year dummy variables b X X R 2 0.73 Observaions 7500 a. Load is a dummy variable equal o one for funds wih load charges b. Includes a dummy variable for each muual fund and one for each year 40
I is unclear wheher hose funds charging loads earn reurns sufficien o offse he addiional fee charged o invesors. By law, a muual fund may charge up o an 8.50 percen load charge [Ippolio, 1989]. The resuls obained by equaion 3 indicae ha such a fee would be offse ypically wihin one o five years of he purchase of he fund. On he oher hand, he resuls obained by equaion 4 indicae ha funds charging a load fee do no earn reurns higher or lower han no-load funds. TABLE IV Effec of Expenses and Load fees on Performance [Sharpe fund -Sharpe S&P500 ], 1995-2004 Variable Mean (4) Expense Raio 1.431-0.15 (16.35) Load a 0.395-0.018 (0.49) Consan X 0.19 (1.25) R 2 0.22 Observaions 962 a. Load is a dummy variable equal o one for funds wih load charges V. Conclusion This paper examined cos efficiency in muual fund indusry using a model in which i is cosly for porfolio managers obain informaion abou securiies. The daa and mehodology are similar o ha of several papers ranging in ime from he 1960s o he 1990s, mos noably ha of Ippolio [1989] and Jensen [1968]. The CAPM and Sharpe Raio were used o analyze he risk-adjused reurns of 962 U.S. domesic equiy muual funds over he period 1995-2004. I was found ha acively managed funds failed o mee heir objecive and ouperform he marke, defined by his sudy as he S&P 500 index, on a risk-adjused basis. The overall mean alpha for he muual fund indusry was -0.17, wih 45 funds characerized by saisically significan negaive alphas, and only 12 funds wih saisically significan posiive alphas. In addiion, only 40 percen of funds in he sample were found o ouperform he Capial 41
Marke Line over he en year period when using he Sharpe Raio as a proxy of risk-adjused reurns. The resuls found using he CAPM were similar o ha of Jensen [1968], bu conradicory o hose found by Ippolio [1968]. The presence of such conradicory resuls should lead o fuure research o find why he indusry alpha in he muual fund indusry changes over ime or differs depending on he sample period. Following he mehodology of Ippolio [1989], OLS regression analysis was also used o assess cos efficiency in he muual fund indusry. In he equilibrium of he model esed, porfolio managers were assumed o be able o ouperform he marke by an amoun exacly equal o he cos required o obain and use he informaion which hey used o rade hus, invesors earn he same reurn in index funds and acive funds. Resuls, using OLS mehodology, did no suppor evidence ha he muual fund indusry was in equilibrium during he sample period, or even perhaps ha such a model governs he muual fund indusry. I was found ha funds wih higher expense raios, on average, earned lower raes of reurn afer expenses. Thus, hese funds did no earn raes of reurn ha were sufficien o offse he higher managemen fees hey charge invesors. From he analysis presened in his paper, i is unclear wheher funds charging load fees did earn raes of reurn ha were sufficien o offse heir sales charges. The regression based off of he CAPM showed ha a load charge would be offse by higher reurns wihin a one o five year period on average. However, he regression using he Sharpe Raio indicaed ha load funds earn reurns ha are insignificanly differen from no-load funds. These resuls sugges ha raional invesors should ake expense raios ino accoun when making muual fund invesmen decisions, and migh consider cheap passive porfolio managemen as a superior opion o ha of acive fund managemen. Alhough, i should be reieraed ha he resuls presened in his paper are in alignmen wih some pas sudies, while conradicory o ohers. This suggess ha sudies on muual fund efficiency may be dependen on boh he mehodology and, more imporanly, he ime periods used in he sudy. Fuure research using muliple long-erm ime periods migh shed more ligh on he effecs of coss on muual fund reurns. 42
REFERENCES Bogle, John C. An Index Fund Fundamenalis: Goes Back o he Drawing Board. Journal of Porfolio Managemen, Spring 2002, v. 28, iss. 3, pp. 31-38 Damodaran, Aswah, Hisorical Reurns on Socks, Bonds, Bills Unied Saes, Damodaran Online, Feb. 2005 <hp://pages.sern.nyu.edu/~adamodar/new_home_page/daa.hml> Elon, Edwin J., Marin Gruber, Sanjiv Das, and Mahew Hlavka, Efficiency wih Cosly Informaion: A Reinerpreaion of Evidence from Managed Porfolios, The Review of Financial Sudies, v. 6, no. 1, 1993, pp. 1-22 Fama, Eugene F., Efficien Capial Markes: A Review of Theory and Empirical Work, Journal of Finance, 1970, pp. 383-417 Friend, Irwin, Marshall Blume, and Jean Crocke, Muual Funds and Oher Insiuional Invesors, New York: McGraw Hill, 1970 Grossman, Sanford, On he Efficiency of Compeiive Sock Markes When Trades Have Diverse Informaion, Journal of Finance, 1976, pp. 573-585 Grossman, Sanford, and Joseph Sigliz, On he Impossibiliy of Informaionally Efficien Markes, American Economic Review, 1980, pp. 393-408 Ippolio, Richard A., Efficiency Wih Cosly Informaion: A Sudy of Muual Fund Performance, 1965-1984, The Quarerly Journal of Economics, Vol.104, No. 1, 1989, pp. 1-23 Jensen, Michael C., The Performance of Muual Funds in he Period 1945-1964, Journal of Finance, 1968, pp. 389-416 Morningsar Premium Fund Screener (Daabase). Morningsar, Inc. November, 2005 <hp://screen.morningsar.com/advfunds/selecor.hml?fsecion=toolpremiumscreener> Reilly, Frank K., and Keih C. Brown, Invesmen Analysis and Porfolio Managemen, 7h Ediion, Unied Saes: Thomson Souh Wesern, 2003 Sharpe, William F., Capial Asses Prices: A Theory of Marke Equilibrium Under Condiions of Risk, Journal of Finance, 1964, pp. 425-442 Sharpe, William F., Muual Fund Performance, Journal of Business, January 1966, pp. 119-138 43
Appendix A: DATA DEFINITIONS Lised below are he daa definiions of all fund variables obained from he Morningsar Premium Fund Screener daabase: Expense Raio The expense raio of a muual fund expresses he percenage of asses deduced each fiscal year for fund expenses. These expenses include 12b-1 fees, managemen fees, adminisraive fees, operaing coss, and all oher asse-based cos incurred by he fund. The expense raios used in his analysis are hose repored as of December 31s of 2004 by each fund. I should be noed ha hese expense raios for railing reurns-as year by year expense raio daa was no available. Therefore, i is an implici assumpion of his analysis ha he expenses of hese equiy funds have eiher all sayed he same for he pas five years or have all changed up or down by he same proporion over he various ime periods. Fund Reurns Annual oal reurns are calculaed on a calendar-year basis. This reurn includes boh income, given in he forms of dividends, and capial gains or losses. Morningsar, Inc. calculaes oal reurn by aking he change in he fund s NAV, assuming reinvesmen of all income and capial gains disribuions during he period, and hen dividing by he iniial NAV. These reurns are adjused for expenses included in a funds expense raio. No-Load Funds No load funds are sold o do-i-yourself invesors and hus carry no sales charge. Because of he variey and complexiy of possible sales charges and markeing fees, i is difficul o creae hard and fas rules ha separae load and no-load funds. Morningsar currenly defines no-load funds as hose offerings ha have no fron-end or deferred load, and a 12b-1 fee less han or equal o 0.25% per year. Oher Daa Issues-Survivorship Bias Like many oher sudies dealing wih muual funds, his analysis mus deal wih fund survivorship. For his sudy, only funds which sill exis oday will be 44
included-as daa for funds ha have closed were no available. This issue also creaes anoher issue for analyzing pas reurns of funds. Since poor performers end o drop ou while srong performers coninue o operae, his cause an overesimaion of pas reurns. This is known as survivorship bias. Assuming ha more acive funds drop ou over ime (as poor performance is usually defined by railing a benchmark/index), i may be appropriae o keep in mind ha he overall average reurns for acive funds is oversaed in his sudy. For example, he Wall Sree Journal repored in 1997 ha during he ime period 1982-1992 muual funds repored average reurns of 18.1%. When survivorship bias was aken ino accoun, average fund reurns were aken down o 16.3%. q 45