Focus on “Average” Mutual Fund is a Straw-man Argument: Fidelity Research Institute
| Mar 20th, 2007 | Filed under: CAPM / Alpha Theory | By: Alpha Male |
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The Right Answer to the Wrong Question: Identifying Superior Active Portfolio Management
By: W.V. Harlow, Fidelity Research Institute & Keith Brown, University of Texas
Published: Fourth Quarter 2006, Journal of Investment Management
The search for alternative beta aims to explain some of the unexplained magic and mystery behind hedge fund management. Once we strip these betas from a hedge fund’s return stream, we often conclude that average hedge fund doesn’t have enough alpha left over to justify its fees. Sure, some funds beat their benchmarks. But on average, many say, managers produce no alpha - or worse yet – negative alpha.
But do you need to invest in the average hedge fund (or actively managed mutual fund)? What if you were better than average at picking good managers? In this study, Harlow and Brown say we shouldn’t get obsessed with the ”average” mutual fund manager. Instead we should simply find “good” managers. They call focusing on the average mutual fund a straw-man argument – chosen by indexers because it’s easy to refute:
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Having read the study, I agree with you that it’s a very useful work. A statistically significant and positive alpha can lead to outperforming the market, particulalry when combined with a low expense ratio. Unfortunately, there are two problems with investors using this inofrmation. As you point out, marketing power has overtaken performance as the measure of success in the mutual fund industry. And, even if investors can find studies such as the above, they can’t use it to generate a list of funds in which to invest.