Performance Persistence of Fixed Income Mutual Funds

By Droms, William G.; Walker, David A. | Journal of Economics and Finance, Fall 2006 | Go to article overview

Performance Persistence of Fixed Income Mutual Funds


Droms, William G., Walker, David A., Journal of Economics and Finance


Abstract

The "winner-winner, winner-loser, gone" methodology allows tests for short-term performance persistence for government and corporate fixed income mutual funds from 1990 to 1999. Persistence occurs when "winner" (loser) funds remain "winner" (loser) funds. If intermediate-term (long-term) bond returns are higher than long-term (intermediate-term) bond returns for successive years, the zstatistic is positive. Persistence is negative in the opposite case, and the pattern holds for longer lag periods. Statistical significance and consistency between the sign of persistence and bond returns indicates persistent returns on bond funds, but the nature of persistence is driven by changes in interest rates. (JEL G11)

Introduction

This study provides an analysis of performance persistence of fixed income mutual funds. Fund performance is defined to "persist" if, for consecutive time periods, the fund return is above (below) the median of all funds after being above (below) the median in the previous period. Studies by Grinblatt and Titman (1992), Hendricks et al. (1993). Goetzmann and Ibbotson (1994). Brown and Goetzmann ( 1995), Malkiel ( 1995), Elton et al. ( 1996), Carhart ( 1997), and Droms and Walker (2001 ) have tested the persistence of equity mutual fund total returns over time periods ranging from 10 to 31 years. Grinblatt and Titman ( 1992) find evidence that differences in performance between funds persist over time and that this persistence is consistent with the ability of fund mangers to earn abnormal returns. Hendricks et. al. ( 1993) find that the relative performance of no-load, growth-oriented mutual funds persists in the near term, with the strongest evidence for a one-year time horizon. Goetzmann and Ibbotson (1994) find strong evidence that past mutual fund performance predicts future performance. Their data suggest that both "winners" (funds with returns above the median) and "losers" (funds with returns below the median) are likely to repeat, even when performance is adjusted for relative risk. Brown and Goetzmann (1995) find that relative risk-adjusted performance of mutual funds persists but that persistence is mostly due to funds that lag the S&P 500; the implication of their results for investors is that the persistence phenomenon is a useful indicator of which funds to avoid.

Malkiel ( 1995) finds that funds in the aggregate have underperformed benchmark portfolios even before deduction of expenses and that while considerable performance persistence existed during the 1970s, there was no consistency of performance during the 1980s. Elton et al. (1996) find that riskadjusted performance tends to persist: funds that did well in the past tend to do well in the future. Using Jensen's alpha as a measure of risk-adjusted performance, their paper shows that primarily oneyear alphas provide information about future performance and that portfolios based on past performance significantly outperform equally weighted portfolios of funds. Carhart ( 1997) develops a 31 -year data sample free of survivor bias and demonstrates that common factors in stock returns and investment expenses almost completely explain persistence in equity mutual funds' mean and riskadjusted returns; his results do not support the existence of skilled or informed mutual fund managers. Droms and Walker (2001) find strung short-term performance persistence fur international equity funds, but no performance persistence fur holding periods of two, three, or four years.

These persistence studies focus on equity mutual funds. There is very little published on the persistence of fixed income mutual funds. Most of the recent literature, such as Busse (2001 ). Choi and Murthi (2001 ). and Wermers (2000). focus on performance of stock mutual funds. Chan et al. (2003) examine the persistence of long-term stock growth rates on the basis of median operating performance. Several other recent papers, such as ter Horst and Verbeek (2000), examine various properties of performance measures and estimators. …

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