Explaining the Performance of Domestic Equity Mutual Funds

Abstract

Using data over 1992Q1–2000Q1, the authors evaluate the ability of various publicly available mutual fund attributes to explain subsequent domestic equity fund returns. Risk and investment style explain a great deal of the variability in mutual fund returns during this period, but the relationship between these attributes and future fund returns changes dramatically from quarter to quarter. Past performance and expenses explain less of the variability in subsequent fund returns, through relationships that are much more consistent over the period. The recommendation is to choose an asset allocation based on the investor's risk tolerance and implement it using funds with good past performance and low expenses. Investors who are not market or style timers should diversify across fund styles, as good past performance and low expenses alone are not powerful enough to offset the damage from investing heavily in a style that goes out of favor.