Do Mutual Funds Differ in Performance? Evidence from Canadian Equity Funds

Mutual funds have experienced phenomenal growth in recent years. There are many reasons behind this development. Most important, mutual funds offer investors an opportunity to diversify their investment, a privilege which, up until very recently, was available only to large and institutional investors. Frequently firms selling mutual funds try to appeal to potential investors by advertising their three-year, five-year and even ten-year rates of return. To mutual fund investors, this sort of advertisement can be quite misleading. The period averages of this type mask the peaks and valleys in performance. A fund’s unit price, for instance, can quadruple in one year only to be followed by several years of marginal or even negative growth. Even in a situation like this, the fund can enjoy an exceptionally high period average. A more realistic picture of the fund’s performance is given by its year-to-year performance. This is not all, mutual fund firms very often claim to have scored better than others in the business. Some even go to the extent of claiming that they have outperformed the market. Not surprisingly, as the mutual fund business becomes more competitive, claims of superior performance are increasingly being made to attract clients. Notwithstanding the advantages of investing in mutual funds, claims of superior performance go counter to the efficient market hypothesis.1 According to this hypothesis, prices always fully reflect the intrinsic value of the underlying assets. Since each agent has ready access to all relevant information, no agent can do better than others in picking winners or predicting the market. A version of this efficient market hypothesis is contained in the theory of the random walks.2 The random walks theory recognizes that neither information gathering nor information processing is a perfect science. Thus, at any given point in time, price may diverge from the intrinsic value of an asset. But, because of randomness in the behaviour of prices, no agent can systematically benefit from following any rule or strategy. It also means that competition will ultimately equalize the marginal benefit of security research or stockpicking and the marginal cost of the research.3 One implication of an efficient market is that firms should pay less attention to analyzing securities or guessing the market and more to reducing the transaction costs and improving the service. The main objective of this article is to statistically test the validity of the claim of superior performance by the mutual fund firms. For reasons explained later, we have limited our analysis to funds specializing in Canadian equities. Since claims of superior performance are almost always made on the grounds of superior management, a one-factor analysis of variance has been chosen as the appropriate methodology. Section one presents some basic statistics pertaining to Canadian equity funds. The results of the analysis of variance tests are given in section two. Section three concludes.