Active mutual fund management : does it offer superior unadjusted and risk-adjusted returns?

Abstract

This dissertation undertakes a comparative analysis contrasting the unadjusted and risk-adjusted returns of open-ended active mutual funds against a passive benchmark, the S&P 500 Index (SPX). The underlying motivation behind this study is to provide the average retail investor with a detailed guide to understand which investment strategy provides the best returns, both in absolute terms, and after accounting for risk. When drawing on the empirical evidence, several different methods have been used over the years. Considering investors tend to prioritise the capacity for wealth generation and risk mitigation, it was concluded that a two-step methodology was required to take these considerations into account. The first step made use of the absolute return percentages to analyse the data from a cross-sectional, panel-level and sub-sample period perspective to provide a thorough assessment on the capacity for wealth generation for both active and passive investment strategies. The second step turned to risk-adjusted models, namely the Sharpe, Treynor, Sortino and Information Ratio. This information offers a clear depiction of which investment strategy offers its investors better returns taking risk exposure into account, with each risk model providing a different perspective depending on the quantification of risk. The findings obtained suggest that a passive strategy is best suited for investors that prioritize wealth generation, with the benchmark outperforming mutual funds in 79% of observation in the cross-sectional assessment and only 11% of those mutual funds outperforming the SPX cumulatively in the panel-level assessment. Additionally, in all four sub-sample periods, the benchmark outperforms mutual funds in all cases. However, it was noted that mutual funds may provide value in terms of loss mitigation during periods of negative returns. For the risk-adjusted results, the data was more mixed. The Sharpe values and Information Ratio values suggest that the benchmark is superior in terms of generating risk-adjusted returns. The Treynor and Sortino values, on the other hand, yield somewhat balanced results.