Measuring Mutual Fund Performance with Characteristic‐Based Benchmarks

TLDR

The study develops and applies new performance measures that benchmark mutual funds against portfolios constructed from the characteristics of the stocks they hold. Benchmarks are built from 125 passive portfolios matched on market capitalization, book‑to‑market, and prior‑year return, and the authors use them to create Characteristic Timing and Characteristic Selectivity metrics, which they apply to a database of over 2,500 equity funds from 1975 to 1994. Results indicate that while aggressive‑growth funds display some selectivity, none of the funds exhibit characteristic timing ability.

Abstract

ABSTRACT This article develops and applies new measures of portfolio performance which use benchmarks based on the characteristics of stocks held by the portfolios that are evaluated. Specifically, the benchmarks are constructed from the returns of 125 passive portfolios that are matched with stocks held in the evaluated portfolio on the basis of the market capitalization, book‐to‐market, and prior‐year return characteristics of those stocks. Based on these benchmarks, “Characteristic Timing” and “Characteristic Selectivity” measures are developed that detect, respectively, whether portfolio managers successfully time their portfolio weightings on these characteristics and whether managers can select stocks that outperform the average stock having the same characteristics. We apply these measures to a new database of mutual fund holdings covering over 2500 equity funds from 1975 to 1994. Our results show that mutual funds, particularly aggressive‐growth funds, exhibit some selectivity ability, but that funds exhibit no characteristic timing ability.