Beat the Index or Bite the Dust? An Empirical Study on the Relationship between Level of Activity and Fund Performance in the US Mutual Fund Market

Snivills Danielsson & Hampus Trotzig

Student thesis: Master thesis

Abstract

The million dollar question, whether investors should invest their capital in actively managed or passively managed funds, have been debated for many years. The interest among investors for passively managed funds, namely index funds and ETF:s, has over the last years seen a steady increase. This has resulted in substantial net capital inflows to such funds while the opposite has been observed for actively managed funds. This study investigates if the level of active management is a determinant of abnormal returns for actively managed domestic US mutual equity funds and how this has changed over time as the US equity fund market has become more and more passively invested. This study performs time-series regressions on portfolios of US mutual equity funds with an investment focus in the US covering the period 1998 to 2017. The portfolios are sorted according to both tracking error, measured as the standard deviation of the difference between the return achieved by a fund and the return of its benchmark index, and size, which is measured as total net assets. This segmentation aims to determine whether more active funds are rewarded for their activity or penalized by market efficiency as well as whether the size of a fund is a relevant determinant of abnormal return. Both the full 20-year sample period and non-overlapping 5-year subperiods are examined. The results show no evidence that the level of active management act as a determinant of abnormal returns and active management display little or no ability to generate abnormal returns. This further implies that the market is efficient and that investors’ flight to passive investment alternatives is warranted

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2018
Number of pages152