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XVI. Another Puzzle: The Growth In Actively Managed Mutual Funds

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THE PERFORMANCE OF PUBLICLY OFFERED COMMODITY FUNDS

Edwin J. Elton, Martin J. Gruber and Joel C. Rentzler, Financial Analysts Journal, July-August 1990.

NEW PUBLIC OFFERINGS, INFORMATION, AND INVESTOR RATIONALITY: THE CASE OF PUBLICLY OFFERED COMMODITY FUNDS

Edwin J. Elton, Martin J. Gruber and Joel C. Rentzler, Journal of Business, 1989.

PROFESSIONALLY MANAGED PUBLICLY TRADED COMMODITY FUNDS

Edwin J. Elton, Martin J. Gruber and Joel C. Rentzler, Journal of Business, April 1987.

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EFFICIENCY WITH COSTLY INFORMATION: A REINTERPRETATION OF EVIDENCE FROM MANAGED PORTFOLIOS

Edwin J. Elton, Martin J. Gruber, Sanjiv Das, and Matthew Hlavka, The Review of Financial Studies, 1993.

THE PERFORMANCE OF BOND MUTUAL FUNDS

Christopher R. Blake, Edwin J. Elton, and Martin J. Gruber, Journal of Business, July 1993.

FUNDAMENTAL ECONOMIC VARIABLES, EXPECTED RETURNS, AND BOND FUND PERFORMANCE

Edwin J. Elton, Martin J. Gruber, and Christopher R. Blake, Journal of Finance, September 1995.

SURVIVORSHIP BIAS AND MUTUAL FUND PERFORMANCE

Edwin J. Elton, Martin J. Gruber, and Christopher R. Blake, The Review of Financial Studies, 1996.

THE PERSISTENCE OF RISK-ADJUSTED MUTUAL FUND PERFORMANCE

Edwin J. Elton, Martin J. Gruber, and Christopher R. Blake, Journal of Business, April 1996.

ANOTHER PUZZLE: THE GROWTH IN ACTIVELY MANAGED MUTUAL FUNDS

Martin J. Gruber, Journal of Finance, July 1996

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AVERAGE PERFORMANCE

INDEX FUNDS

CLOSED END FUNDS

THE PERSISTENCE OF PFORMANCE

EXPENSES

WHAT ACCOUNTS FOR CASH FLOWS

HOW WELL DO INVESTORS DO

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Customer Services – Including Record Keeping, The Ability To Move Money Around Among Funds, and Daily Valuation

Low Transaction Costs

Low Cost Diversification

Professional Management (Security Selection)

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OPEN END MUTUAL FUNDS SELL AT

NET ASSET VALUE. IF “GOOD

MANAGEMENT” EXISTS, A FUND

WHICH HAS SUPERIOR

MANAGEMENT WILL SELL AT NET

ASSET VALUE. IF BAD

MANAGEMENT EXISTS, A FUND

WHICH HAS INFERIOR

MANAGEMENT WILL SELL AT NET

ASSET VALUE. MANAGEMENT IS

NOT PRICED.

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INDEX FUNDS

1985 3 S&P FUNDS1.24%

1 SMALL STOCK0.88%

NO GROWTH, VALUE,

OR BOND FUND

1994 OVER 100 INDEX FUNDS

44 S&P FUNDS 0.19% TO

1.35%

GOOD TRACKING (R2=.997)

LOW COST

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A. A SOPHISTICATED CLIENTELE

B. A DISADVANTAGED CLIENTELE

1. UNSOPHISTICATED INVESTORS

2. INSTITUTIONALLY DISADVANTAGED INVESTORS

3. TAX DISADVANTAGED INVESTORS

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Taxes and the Advantage of Passive Management

Active management turns over portfolios about once a year

Passive management buys and holds

Passive management gets to compound returns on before capital gains taxes value

If taxes are high enough and horizon long enough, then passive management is better than active management with reasonable estimates of alpha

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Model of Horizon Values – Assumptions

Tax on dividends paid once a year

For active funds tax on capital gains paid once a year

For passive funds tax on capital gains paid at horizon

Investor reinvests all funds net of taxes end year where

V0 = starting investment at time 0,

IVN = end of horizon after tax wealth if invested in index funds,

AVN = end of horizon after tax wealth from active management,

RM = return on the market including dividends,

RE = the expense ratio for index funds,

RD = dividend yield,

RA = extra return from active management,

TI = tax on dividends,

TCG = tax on capital gains,

N = number of years in investment horizon

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Index Funds

0 1

1 1 01

]

1 1

[ 1

N

N M E D CG

N

D t CGt

IV V R R R T T

R V T V T

where

tIDEMt TRRRV 10

Active Management

NIDCGDAMN TRTRRRVAV 1110

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