1. #1

    Join Date
    Aug 2011
    Lahore, Pakistan
    Blog Entries

    Information asymmetry and not skill which helps mutual funds

    Should you use mutual funds for investment in stock market? The answer is yes as well as no. Yes, because mutual funds can do wonders for your investments and no because mutual funds do little for your investments. This sounds strange, but it is true. Mutual fund performance is so market specific that performance can sound just opposite. In order to understand this, let us look at two different examples. Comparison of USA would be relevant in this context.

    As per one of study done in 2014 in USA,
    “Just 26% of domestic stock-fund managers were able to deliver higher returns than their respective index benchmark over the past five years through June, according to S&P Dow Jones Indices. Even more sobering, in this same bullish period, 87% of large-cap stock-fund managers failed to beat the S&P 500”.
    So if mutual funds fail to beat market, how can they be relied upon?

    Mutual funds do not perform so badly when it comes to a country. In fact, they do really well. More than sixty percent of mutual funds have been able to beat market comprehensively. As per a report in the Business Standard last year,” Over two-thirds of equity mutual fund schemes have outperformed their benchmark indices in the last five-year period. Of the 280-odd equity schemes that have been in existence for five years or more, 190 funds or about 70 per cent of those funds have outperformed their respective benchmark indices. The out-performance percentage remains the same across the three-year and one-year period with seven of 10 funds outperforming their benchmarks.”

    So why that is mutual funds beat mutual fund so comprehensively?

    One of the key contributors for this stark difference in performance can be information asymmetry. Information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. Since markets are not perfect, information asymmetry is very common unlike US market where this tendency of information disparity is very limited or restricted. In the study, Luck versus Skill in the Cross-Section of Mutual Fund Returns, Fama and French analyze a portfolio of actively managed US equity mutual funds, where each funds contribution to the portfolio depends on the value of assets under management. The authors measure the portfolios alpha—the difference between the portfolios actual return and expected return—which is typically used to assess an active fund managers performance. Fama and French estimate that from 1984 to 2006 the aggregate active fund portfolio under-performed by 0.8 percentage points per year”.

    So are skill and information asymmetry one and the same. Answer is a form no. Skill means proficiency, facility, or dexterity that is acquired or developed through training or experience. Access to additional information can be just because you are a part of the system while the other person is not. It is not just the skill. An investor with a large cap mutual fund can be more assured about good returns, while in USA an investor can feel more comfortable about his returns when he is just following an index fund.

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