United States-Based International Mutual Funds: Performance and Persistence
Fan, Yuhong, Addams, H. Lon, Financial Services Review
This study examines market behavior of U.S.-based international mutual funds that invest solely in the international equity markets from 2005 to 2009. With a reputation of high expense ratio, these funds outperform the stock market indices; and their performances can be explained by fund characteristics, such as size, turnover ratio, and beta. Funds are categorized as winners or losers based on their relative performance in the category. The probability of winner funds becoming loser funds or vice versa is close to 50%. The post one- to three-year annualized returns for winner funds and loser funds are very similar. Thus, the relative performance of one fund to another appears more like a random walk than a persistent trend. © 2012 Academy of Financial Services. All rights reserved.
JEL classification: G11
Keywords: International mutual fund; Performance; Performance persistence
The first international mutual fund was introduced in the United States in 1955. By the end of 2008, international equity mutual funds accounted for 9% of mutual fund industry assets.1 The fast growth of international mutual funds can be attributed to their most prominent benefit of the diversification function, while this is hard to achieve from direct investing by individuals in the international market (Grubel, 1968; Levy and Sarnat, 1970). The fast economic growth of the emerging markets (Li and Lin, 2011) also helps to explain the growth of the United States-based international funds, because mutual fund investors believe there exists a higher degree of market inefficiency in emerging markets than in the U.S. market (Tkac, 2001).
Mutual fund performance is always an attractive topic for both researchers and investors because investment performance is the most influential of the many factors that shape fund owners' opinions of the fund industry.2 If it is true the degree of market inefficiency is higher in the international market, domestic investors would want to spend even more effort doing research on international funds to find the most rewarding investments. Although there exists a large amount of literature regarding domestic fund performance (Fortin and Michelson, 2002; Lin and Yung, 2004; Dowen and Mann, 2004; Haslem, Baker, and David, 2008), we find very few studies that have examined international mutual fund performance. Fortin and Michelson (2005) studied the relative performance of international funds versus the market index. Their findings support the existence of market inefficiency in the international market and, thus, investors are benefited by selecting actively managed international funds to capture the inefficiency. Moreover, they explored the relation between funds' return and characteristics, and they found that size and turnover can contribute to funds' return but not the expense ratio. From an individual investor's position, the fund characteristics, such as load, turnover ratio, size, manager's tenure, and star rating are most convenient to observe and utilize. Thus, it is meaningful to investigate fund performance relative to these characteristics to facilitate investors as they construct more effective portfolios.
This study focuses on United States-based international funds that solely invest in the equity market outside of the United States. Evaluating performance of international funds is relatively challenging compare to evaluating performance of domestic funds because of the lack of appropriate benchmarks for international funds. For example, even the most sophisticated data gathering company, Morningstar, uses only one single benchmark (MSCI EAFE)3 to measure performance of all international funds. In this study, we use classical measures to analyze international fund performance, such as three-year and five-year annualized returns, fund alpha, sharp ratio, and Morningstar rating. We do not use factors models, which are most commonly seen in studies for domestic mutual funds to examine returns, because we believe there may be lack of a common set of factors to explain international fund returns. …