Mutual Fund Style Analysis: A Stochastic Dominance Approach

It is a well-known fact that actively managed mutual funds on average underperform passive benchmarks. In this paper, we use the stochastic dominance test proposed by Linton, Maasoumi, and Whang (2005) to shed new light on mutual fund performance on average and across styles. This test evaluates mutual fund performance using a non-parametric framework that 1) imposes a minimal set of conditions on preferences; and 2) analyzes the entire return distribution for each mutual fund group. We find little evidence that actively managed mutual funds on average underperform the passive benchmark, suggesting that mutual fund performance results are highly sensitive to investor preference assumptions. Exploring the returns for different styles of mutual funds, we find that aggressive mutual funds underperform the market for risk-averse investors, whereas both growth & income and income funds outperform the market for prudent investors. Furthermore, we find that mutual fund portfolios formed by the stochastic dominance approach provide superior future performance.