Mutual Fund Objectives: Do They Provide a Useful Guide for Investors?

Mutual funds, like most firms, are required to state their objectives in their prospectuses upon registration. We examined whether these objectives convey information about the performance of the funds that uniquely distinguishes them from funds with other objectives. This issue appears to be particularly critical for mutual funds, because they are able to alter their asset portfolios more readily and with less timely public knowledge than most other firms. In addition, most of the funds use their objective as part of their names so that investors are made aware of the objective. There are some plausible reasons for performance to deviate from the objectives. It is conceivable, or even likely, that the fund managers cannot consistently identify securities of firms whose performance is congruent with their objectives. Furthermore, they may not be able to find a sufficient number of firms whose attributes fit the objective of the fund. In this case, they may find their selection to be further limited by the regulatory restrictions on the proportion of ownership they are allowed to hold in any single firm. The larger funds are more likely than smaller funds to have exhausted their selection pool, so they are more likely to deviate from their objectives as they continue to grow. This issue is also examined. The possibility that fund managers purposefully alter their portfolios to pursue a different objective than stated cannot be denied, but this is not testable. This study differs from a few past studies in several ways. It uses a much larger and more recent data base with a greater number of objective categories. The data were subjected to more rigorous statistical tests than were used before. Two time periods were examined to see if fund performance for objective categories changed in comparison to other categories over time. We used the objectives stated in the prospectuses of the funds; whereas, the prior studies used objectives based in part on judgement.