TAILIEUCHUNG - Luck versus Skill in the Cross-Section of Mutual Fund Returns

Transparency, predictability and longevity of government programmes are necessary if investors are to initiate a project in green technologies. For instance, the degree of high uncertainty in American Production Tax Credits (PTC) was a contributing factor to investor exit from the wind power sector, in particular - illustrating the importance for governments of ensuring that programmes are not subject to excessive policy uncertainty (see Figure 2). Retroactive policy changes regarding solar power projects in Spain have also been concerning investors. 18 Meanwhile, a survey conducted by the Institutional Investors Group on Climate Change (IIGCC) found that less than 10%. | THE JOURNAL OF FINANCE VOL. LXV NO. 5 OCTOBER 2010 Luck versus Skill in the Cross-Section of Mutual Fund Returns EUGENE F. FAMA and KENNETH R. FRENCH ABSTRACT The aggregate portfolio of actively managed . equity mutual funds is close to the market portfolio but the high costs of active management show up intact as lower returns to investors. Bootstrap simulations suggest that few funds produce benchmark-adjusted expected returns sufficient to cover their costs. If we add back the costs in fund expense ratios there is evidence of inferior and superior performance nonzero true a in the extreme tails of the cross-section of mutual fund a estimates. There is a constraint on the returns to active investing that we call equilibrium accounting. In short details later suppose that when returns are measured before costs fees and other expenses passive investors get passive returns that is they have zero a abnormal expected return relative to passive benchmarks. This means active investment must also be a zero sum game aggregate a is zero before costs. Thus if some active investors have positive a before costs it is dollar for dollar at the expense of other active investors. After costs that is in terms of net returns to investors active investment must be a negative sum game. Sharpe 1991 calls this the arithmetic of active management. We examine mutual fund performance from the perspective of equilibrium accounting. For example at the aggregate level if the value-weight VW portfolio of active funds has a positive a before costs we can infer that the VW portfolio of active investments outside mutual funds has a negative a. In other words active mutual funds win at the expense of active investments outside mutual funds. We find that in fact the VW portfolio of active funds that invest primarily in . equities is close to the market portfolio and estimated before expenses its a relative to common benchmarks is close to zero. Since the VW portfolio of active funds produces

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