Active mutual fund managers show superior ability to select stocks

A paper written by ERIM researchers has challenged a long-held belief in the financial sector that actively managed mutual funds have little in the way of investment skills because, on average, they fail to outperform index benchmarks such as the S&P 500.

Instead, the paper’s authors Hao Jiang, <link people marno-verbeek>Marno Verbeek and Yu Wang find that stocks heavily overweighted by active funds (where analysts anticipate greater returns from a stock than expected) perform substantially better than their underweighted counterparts.

By comprehensively studying investment decisions from 1984 to 2008, the authors show the high investment value of the consensus wisdom displayed by active mutual funds.

This outperformance is greater in stocks with more firm-specific information, as well as in those with fewer active mutual funds that compete for private information. The results show that informed investing by active mutual funds enhances the informativeness of stock prices. Finally, by highlighting the factors that constrain individual fund managers to deviate from benchmarks, the authors explain why active mutual funds in aggregate appear passive.

The researchers conclude that, contrary to belief, actively managed mutual funds demonstrate a superior ability to select stocks, and that their costly acquisition and implementation of information helps impound information into asset prices.

The results provide important new insights into the mutual fund industry and stock market efficiency. Economists have long been puzzled by the rapid expansion of the actively managed mutual fund industry and what, up until now, have been as seemingly futile attempts by these funds to outperform passive benchmarks.

• Download Information Content When Mutual Funds Deviate from Benchmarks from SSRN.