The Ability of Actively Managed Mutual Funds to Beat a Benchmark

Abstract

The ongoing discussion regarding the effectiveness of active versus passive investing strategies remains highly relevant in today's investment landscape. The emergence of index funds, a relatively recent development in the financial world, has sparked debates on their potential to dominate the market by 2024, as predicted by Moody's. Supporters of the efficient market hypothesis argue that in efficient markets, index investing should outperform active strategies. Conversely, proponents of behavioral finance and many investment professionals con- tend that markets are inherently inefficient, presenting opportunities for active investors to exploit market anomalies and achieve above-average returns. This debate encompasses both theoretical concepts and practical implications of index investing. This study explores the performance of nine carefully selected Danish actively managed mutual funds compared to the S&P 500 index on a risk-adjusted basis from the start of 2016 to the end of 2023. The evaluation incorporates monthly returns and utilizes five performance metrics: Jensen's alpha, Treynor's ratio, the Sharpe ratio, the Information ratio, and the Fama & French 3-factor model. These metrics are grounded in Modern Portfolio Theory by Markowitz and the CAPM framework. Additionally, the study investigates whether these mutual funds generated abnormal returns during periods of heightened market volatility by analyzing their returns in relation to the volatility index (VIX). The results indicate that the selected Danish actively managed mutual funds did not achieve abnormal risk-adjusted returns when considering all associated risks. A robustness test rein- forces these findings, demonstrating the consistency of the conclusions even when adjusting for the risk-free rate and beta values of the mutual funds. Furthermore, the analysis reveals that these mutual funds were unable to capitalize on periods of increased market volatility. In summary, the selected Danish actively managed mutual funds did not deliver abnormal re- turns when compared to the S&P 500 from 2016 to 2023. Moreover, these funds did not effectively leverage periods of heightened market volatility to their advantage, ultimately resulting in value destruction for their investors. This study contributes to the existing body of research by examining established empirical theories in a relatively new market context, aligning with prior research that suggests index investing as the preferred strategy.