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Performance persistence of international mutual funds
Global Finance Journal 12 (2001) 237 – 248
Performance persistence of international mutual funds William G. Droms*, David A. Walker McDonough School of Business, Georgetown University, Washington, DC 20057, USA Received 16 February 1999; received in revised form 23 March 2000; accepted 13 March 2001
Abstract This study applies the ‘‘winner– winner, winner – loser’’ methodology developed by Brown and Goetzmann, Goetzmann and Ibbotson, and Malkiel to test for short-term performance persistence in international equity mutual funds over the 20-year period from 1977 to 1996. Persistence tests are applied to a database consisting of all international equity funds in existence during this period, varying from a low of 11 (1977) to a high of 473 (1996) funds, reflecting the extremely rapid growth of this asset class over the last 20 years. The authors are not aware of any other persistence studies of international equity funds. The results show statistically significant performance persistence for 1-year holding periods, but no persistence for 2-, 3- or 4-year periods. For 1-year periods, overall, performance persistence is statistically significant at the .001 level. This leads to the conclusion that international equity mutual funds exhibit strong performance persistence for short-term (1-year holding periods), but persistence generally fades after the first year. These results are generally consistent with results found by other researchers using this methodology. Survivorship bias is a concern in virtually all time series studies of mutual fund returns. This bias is minimal in this study because each new fund is added to the database, merging funds continue to be included and adjustments are made for funds that cease operations. The only bias is that if any fund closed and did not merge with an existing fund, that fund would not have returns to be included for the future periods. Only 28 funds ceased operations over the 20-year period during which 490 new funds were introduced. D 2001 Elsevier Science Inc. All rights reserved. Keywords: Mutual funds; Mutual fund performance; International mutual funds
* Corresponding author. Tel.: +1-202-687-3820. E-mail addresses: [email protected] (W.G. Droms); [email protected] (D.A. Walker). 1044-0283/01/$ – see front matter D 2001 Elsevier Science Inc. All rights reserved. PII: S 1 0 4 4 - 0 2 8 3 ( 0 1 ) 0 0 0 3 0 - 8
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1. Introduction This study provides an analysis of the persistence of international equity mutual funds. A fund is defined to ‘‘persist’’ if, for consecutive time periods, it has returns above the median, relative to comparable funds. Studies by Brown and Goetzmann (1995), Carhart (1997), Elton, Gruber, and Blake (1996), Goetzmann and Ibbotson (1994), Grinblatt and Titman (1992), Hendricks, Patel, and Zeckhauser (1993), and Malkiel (1995) have tested the persistence of mutual fund total returns over time periods ranging form 10 to 31 years. Grinblatt and Titman find evidence that differences in performance between funds persist over time and that this persistence is consistent with the ability of fund managers to earn abnormal returns. Hendricks, Patel, and Zeckhauser find that the relative performance of no-load, growthoriented mutual funds persists in the near term, with the strongest evidence for a 1-year time horizon. Goetzmann and Ibbotson find strong evidence that past mutual fund performance predicts future performance. Their data suggest that both ‘‘winners’’(funds with returns above the median) and ‘‘losers’’ (funds with returns below the median) are likely to repeat, even when performance is adjusted for relative risk. Brown and Goetzmann find that relative risk-adjusted performance of mutual funds persists but that persistence is mostly due to funds that lag the S&P 500; the implication of their results for investors is that the persistence phenomenon is a useful indicator of which funds to avoid. Malkiel finds that funds in the aggregate have underperformed benchmark portfolios even before deduction of expenses and that while considerable performance persistence existed during the 1970s, there was no consistency of performance during the 1980s. Elton, Gruber, and Blake find that risk-adjusted performance tends to persist; funds that did well in the past tend to do well in the future. Using Jensen’s alpha as a measure of riskadjusted performance, their paper shows that, primarily, 1-year alphas provide information about future performance and that portfolios based on past performance significantly outperform equally weighted portfolios of funds. Carhart develops a 31-year data sample free of survivor bias and demonstrates that common factors in stock returns and investment expenses almost completely explain persistence in equity mutual funds’ mean and risk-adjusted returns; his results do not support the existence of skilled or informed mutual fund managers. These studies focus on US domestic mutual funds. The current study examines the persistence of international mutual funds. The null hypothesis is that there is no persistence between time periods. Whether or not new funds enter the market, winners in period t are examined to test whether they are winners in period t + j, for j = 1, 2, 3, 4. Cumby and Glen (1990), Droms and Walker (1994), and Eun, Kolodny, and Resnick (1991) provide performance studies of international mutual funds, but none of these studies test for persistence. This study of persistence examines more mutual funds over a longer period of time than previous studies. The results suggest that mutual fund performance does not persist over long periods of time but does exhibit persistence between consecutive time periods. The results suggest that findings of persistence of returns are sensitive to the length of time included in the analysis.
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2. Methodology 2.1. Research issue This study applies the successive ‘‘winner–winner, winner–loser’’ methodology applied by Brown and Goetzmann, Gotezmann and Ibbotson, and Malkiel. Funds are rank-ordered by 1-year total returns with 50% of the funds with the highest returns labeled ‘‘winners’’ and 50% of the funds with the lowest returns labeled ‘‘losers.’’ Funds that ceased operations in the subsequent year are identified as ‘‘gone.’’ Two-by-three tables are constructed to identify funds that are ‘‘winners’’ and ‘‘losers’’ in 1 year and then ‘‘winners,’’ ‘‘losers,’’ or ‘‘gone’’ in successive years. Statistical significance tests (z scores) are employed following the procedure described by Brown and Goetzmann. Chi-square tests of significance also are calculated. 2.2. Approach To examine the persistence of returns for N funds, the returns are rank-ordered from the lowest return R1 to the highest return RN so that the returns form the vector R ¼ ½R1 ; . . . ; R0:5N ; R0:5N þ1 ; . . . ; RN The first half of the returns — R1, . . ., R0.5N — defines the funds that are ‘‘losers’’ and the second half of the returns — R0.5N + 1,...RN — designates the funds that are called the ‘‘winners.’’ Funds with returns equal to the median are also called ‘‘winners.’’ Let L ¼ ½R1 ; . . . ; R0:5N and W
¼ ½R0:5N þ1 ; . . . ; RN :
If only these same funds operate for the next period, the definition of persistence is quite simple. In that case, each element of L either remains in the lower half of the returns or shifts to the upper half of the returns. Likewise, each element of W remains a member of W or does not have returns among the top half of the rank ordering. If a fund is in L for consecutive periods, it is defined as a loser–loser (LL). If a fund remains in the top half of the returns, it is a winner–winner (WW). A fund that shifts from L to W is a loser–winner (LW) and a fund that shifts from W to L is a winner–loser (WL). Funds that cease operations that were ‘‘winners’’ (losers) during the previous period are designated as winner–gone (WG) or loser–gone (LG). In matrix form, the path can be described as
period t
winner loser
period t + 1 winner WW LW
loser WL LL
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Table 1 International mutual fund return tables mean, median, and EAFE returns (%): 1977 – 1996 Year Number of funds New funds Mean Median EAFE returns
1977
1978
1979
1980
1981
1982
1983
1984
1985
11
12 1 23.07 20.25 32.59
13 1 19.75 25.30 4.76
13 0 33.12 26.90 22.56
15 2 0.10 0.50 2.27
20 5 10.91 10.30 1.90
22 2 27.16 28.45 23.69
26 4 4.68 2.90 7.37
34 9 39.86 38.95 56.19
1.87 0.20 18.04
This table shows the total number of funds in the sample each year, the number of new funds introduced each year, the mean and median returns on the funds in the sample, and the comparable return on the Europe, Australia, and Far East Index (EAFE) for each year. There were 11 international funds in existence in 1977. From 1978 – 1996, 490 new funds were added and 28 funds ceased operations, resulting in a sample size of 473 funds in 1996.
The classification is somewhat more complex for two reasons. Between periods t and t + 1, there could be an increasing number of funds or funds that could close. Suppose M new funds are operating in period t + 1, then M + N funds are to be ranked. If K funds close, M + N K funds are to be ranked. After the M + N K funds are ranked, the winners from period t are identified as winners again or losers and the losers from period t are identified as repeat losers or winners. The funds that are new in period t + 1 are ranked, but the matrix path will include only the funds that operate in the consecutive periods.
3. Data Annual mutual fund data are collected for a total of 529 international equity mutual funds that were in operation during the 20-year period from 1977 through 1996. There were only a total of 28 funds that ceased operations over the 20-year period, while 490 new funds were introduced. The data set provides annual data on total returns from the annual Wiesenberger Investment Companies Service (1978–1997). Returns are measured as the percentage annualized total rate of return for the fund (treating all dividends as reinvested), net of fees and expenses and before load charges, where applicable. 3.1. Characteristics Table 1 provides the general characteristics of the data set. The number of international equity funds in the first year (1977) was only 11, and the number increased gradually until 1986. The number more than doubled over the next two years and increased steadily until a large number of new funds began operating each year after 1990. The mean and median returns are presented for all funds operating for each year. For comparison purposes, the return on the Morgan Stanley EAFE also is presented.
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1986 42 8 42.21 42.45 69.45
241
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
68 25 9.82 7.65 24.65
94 28 15.24 14.40 28.26
110 15 22.11 20.55 10.55
123 14 11.69 11.30 23.44
147 33 14.13 13.00 12.13
170 30 3.00 2.80 12.77
222 54 38.58 34.80 32.56
275 58 2.64 2.00 7.77
384 115 8.29 9.65 11.21
473 92 13.51 13.40 6.04
For six of the last 10 years, the mean of the international mutual fund returns is larger than the EAFE returns, and the average return for the international funds was 10.44% versus
Table 2 International return persistence: 1-year lag Year
Total New WW LW LL funds funds (a) (c) (d)
1977 – 1978 11 1978 – 1979 12 1979 – 1980 13 1980 – 1981 13 1981 – 1982 15 1982 – 1983 20 1983 – 1984 22 1984 – 1985 26 1985 – 1986 34 1986 – 1987 42 1987 – 1988 67 1988 – 1989 95 1989 – 1990 110 1990 – 1991 123 1991 – 1992 147 1992 – 1993 170 1993 – 1994 218 1994 – 1995 270 1995 – 1996 383 Total 1791
1 1 0 2 5 2 4 9 8 25 28 15 14 33 30 54 58 115 92 496
2 1 2 3 4 3 6 4 13 12 17 33 29 33 52 43 44 85 125 511
WL Winner Loser Cross z Chi(b) – gone – gone product ratio S.D. Statistic square
3 2 4 5 1 5 5 1 5 5 1 4 4 3 4 7 3 7 4 7 5 8 5 9 3 13 5 8 13 9 19 14 17 17 29 16 25 29 26 25 31 25 14 53 21 37 46 42 63 40 66 65 71 47 67 123 66 384 485 383
0 0 0 0 0 0 0 0 0 0 0 0 0 4 1 0 0 1 1 7
0 0 0 0 0 0 0 0 0 0 0 0 1 5 6 2 5 1 1 21
0.33 0.04 0.08 0.15 0.75 0.18 2.10 0.28 11.27 2.17 0.74 3.52 1.29 1.64 9.37 1.27 0.42 1.98 3.48 1.69
1.26 1.55 1.38 1.34 1.04 0.98 0.87 0.83 0.83 0.63 0.49 0.43 0.38 0.38 0.40 0.31 0.28 0.25 0.21 0.10
0.87 2.08 1.83 1.42 0.28 1.74 0.85 1.55 2.92 1.23 0.62 2.92 0.67 1.31 5.65 0.78 3.06 2.72 5.80 5.43
0.08 3.00 2.01 0.85 0.06 1.80 0.18 1.39 7.69 0.86 0.14 7.61 0.23 1.32 35.11 0.39 8.89 6.88 33.68 29.60
This table shows performance persistence with a 1-year lag. Winners and losers are ranked relative to the median fund in Year 1 and reranked in Year 2. Winners are funds with returns above the median and loser are funds with returns below the median. Funds ceasing operations are identified as gone.
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Table 3 International return persistence: 2-year lag Year
Total New WW WL LW LL funds funds (a) (b) (c) (d)
1977 – 1979 11 1978 – 1980 12 1979 – 1981 13 1980 – 1982 13 1981 – 1983 15 1982 – 1984 20 1983 – 1985 22 1984 – 1986 26 1985 – 1987 34 1986 – 1988 42 1987 – 1989 67 1988 – 1990 95 1989 – 1991 109 1990 – 1992 114 1991 – 1993 140 1992 – 1994 166 1993 – 1995 216 1994 – 1996 269 Total 1384
2 1 2 7 7 6 13 17 33 53 43 29 47 63 84 112 173 207 899
4 4 4 3 4 6 5 3 7 17 18 20 32 27 35 31 49 74 343
2 2 3 2 3 3 3 4 2 4 4 2 4 3 4 4 3 7 6 5 6 9 8 5 11 8 8 4 9 12 16 20 13 29 25 20 21 19 29 27 18 35 38 31 34 53 49 28 61 73 31 59 68 66 353 352 308
Winner Loser Cross z Chi– gone – gone product ratio S.D. Statistics square 0 0 0 0 0 0 0 1 0 0 0 0 2 4 0 0 1 0 8
0 0 0 0 0 0 0 0 0 0 0 1 6 3 2 5 1 2 20
3.00 2.00 0.67 0.38 1.33 3.50 1.00 0.21 0.64 5.67 0.73 0.55 2.33 1.94 1.01 0.33 0.34 1.22 0.85
1.26 1.19 1.15 1.15 1.04 0.94 0.86 0.88 0.70 0.71 0.49 0.42 0.41 0.40 0.34 0.33 0.29 0.25 0.11
0.87 0.58 0.35 0.85 0.28 1.33 0.00 1.79 0.65 2.45 0.63 1.42 2.07 1.67 0.03 3.35 3.74 0.80 1.49
0.08 0.00 0.05 0.09 0.06 0.81 0.18 2.10 0.09 4.95 0.15 1.50 3.78 2.31 0.02 10.73 13.43 0.46 2.11
This table shows performance persistence with a 2-year lag. Winners and losers are ranked relative to the median fund in Year 1 and reranked in Year 3. Winners are funds with returns above the median and loser are funds with returns below the median. Funds ceasing operations are identified as gone.
9.70% average EAFE returns. The standard deviation of the international fund returns (13.49) also is smaller than the standard deviation of the EAFE index (16.49). 3.2. Survivorship bias One of the key issues to be considered for every time series analysis of mutual fund returns is potential survivor bias. This bias is minimal in this study because each new fund is added to the database and merging funds continue to be included. The only bias is that, if any funds closed and did not merge with an existing fund, that fund would not have returns to be included for the year in which operations ceased. Only 28 funds ceased operations while 490 new funds were added. If a fund in the database merged into another fund also in the database, the surviving fund is carried forward and the acquired fund is dropped entirely. If a fund in the database merged into a fund not in the database of if the fund closed, the fund is dropped. Complete data were then assembled for all funds for which the data had been published for the entire 20-year period of 1977–1996. For each test of persistence between periods, there are approximately three times as many previous ‘‘losers’’ that are ‘‘gone’’ than previous ‘‘winners’’ that are ‘‘gone.’’ The authors believe that including all operating funds (new and old) in the returns
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Table 4 International return persistence: 3-year lag Year
Total New WW WL LW LL funds funds (a) (b) (c) (d)
1977 – 1980 11 1978 – 1981 12 1979 – 1982 10 1980 – 1983 12 1981 – 1984 13 1982 – 1985 23 1983 – 1986 20 1984 – 1987 22 1985 – 1988 29 1986 – 1989 46 1987 – 1990 69 1988 – 1991 87 1989 – 1992 110 1990 – 1993 107 1991 – 1994 138 1992 – 1995 132 1993 – 1996 207 Total 1048
2 3 7 9 11 15 21 42 61 68 57 62 77 117 142 227 265 1186
4 4 3 3 4 6 5 3 7 17 17 20 32 27 35 31 49 267
2 2 3 2 3 3 1 1 5 3 2 4 2 1 6 7 7 3 4 3 8 6 6 7 6 11 5 8 10 11 18 17 16 21 17 26 29 17 25 26 23 29 38 33 27 24 37 38 52 59 45 249 249 261
Winner Loser Cross z Chi– gone – gone product ratio S.D. Statistics square 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 0 1 6
0 0 0 0 0 0 0 0 0 0 0 2 6 1 4 2 1 16
3.00 2.00 15.00 2.00 12.00 0.37 3.33 0.58 0.53 2.34 0.89 1.46 1.62 1.31 0.75 1.33 0.72 1.12
1.26 1.19 1.59 1.19 1.38 0.89 0.95 0.90 0.77 0.61 0.49 0.44 0.41 0.39 0.35 0.36 0.28 0.12
0.87 0.58 1.70 0.58 1.79 1.13 1.26 0.60 0.82 1.39 0.24 0.85 1.19 0.69 0.81 0.79 1.18 0.94
0.08 0.00 1.41 0.00 1.86 0.52 0.68 0.03 0.19 1.21 0.00 0.41 1.03 0.24 0.41 0.38 1.09 0.78
This table shows performance persistence with a 3-year lag. Winners and losers are ranked relative to the median fund in Year 1 and reranked in Year 4. Winners are funds with returns above the median and losers are funds with returns below the median. Funds ceasing operations are identified as gone.
ranking in each period and separating funds that did not continue operations(gone) avoids virtually all of the potential survivor bias.
4. Results 4.1. Persistence Tables 2–5 present the results of persistence tests. Table 2 provides the tests for persistence between consecutive periods: t to t + 1. Tables 3, 4, and 5 provide the tests between periods t and t + 2 (2-year lag), t and t + 3 (3-year lag), and t and t + 4 (4-year lag), respectively. The combined results for each of the lag assumptions appear at the bottom of the tables. There are two tests statistics to examine the significance of persistence of returns. One is a z statistic, which is distributed normally with a zero mean and a standard deviation of 1.0. The second test statistic is a chi-square. If the results are strong and highly convincing for each hypothesis, the results of the z test and the Chi-square test will be consistent. This is the case for each test at the bottom of Tables 2–5, which are summarized in Table 6. Table 2 shows that combined results for the 1-year lag period are highly significant and demonstrate positive performance persistence. Fifty-seven percent of all winners in Year 1 are
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Table 5 International return persistence: 4-year lag Year
Total New WW WL LW LL funds funds (a) (b) (c) (d)
Winner Loser Cross z Chi– gone – gone product ratio S.D. Statistics square
1977 – 1981 1978 – 1982 1979 – 1983 1980 – 1984 1981 – 1985 1982 – 1986 1983 – 1987 1984 – 1988 1985 – 1989 1986 – 1990 1987 – 1991 1988 – 1992 1989 – 1993 1990 – 1994 1991 – 1995 1992 – 1996 Total
11 12 13 13 15 20 22 25 34 42 66 91 94 103 132 161 854
0 0 0 0 0 0 0 0 0 1 0 1 1 1 0 1 5
4 8 9 13 20 23 46 70 76 82 90 92 131 175 257 319 1415
3 1 2 3 2 2 5 8 8 8 14 17 22 27 51 55 228
3 3 2 5 5 1 5 4 2 4 4 2 6 6 1 8 8 2 6 6 5 4 11 2 10 10 6 12 12 9 19 18 14 30 18 19 29 22 19 25 22 24 21 30 28 29 35 40 216 214 176
0 0 0 0 0 0 0 0 0 0 1 6 1 4 2 1 15
0.67 0.04 0.20 0.38 0.06 0.06 0.69 0.36 0.48 0.50 0.57 0.60 0.66 1.18 2.27 2.17 0.87
1.22 1.55 1.20 1.15 1.35 1.12 0.86 0.98 0.70 0.63 0.50 0.45 0.42 0.41 0.37 0.33 0.14
0.33 2.08 1.34 0.85 2.13 2.48 0.43 1.03 1.05 1.09 1.11 1.15 1.00 0.40 2.22 2.37 1.02
0.08 3.00 0.67 0.09 3.36 5.00 0.00 0.34 0.50 0.62 0.76 0.90 0.64 0.04 4.27 5.02 0.91
This table shows performance persistence with a 4-year lag. Winners and losers are ranked relative to the median fund in Year 1 and reranked in Year 5. Winners are funds with returns above the median and losers are funds with returns below the median. Funds ceasing operations are identified as gone.
winners in Year 2, 511 (WW) of 894 (WW + WL); 56% of all losers in Year 1 are losers in Year 2, 485 (LL) of 869 (LL + LW) and this difference is statistically significant at the .001 probability level applying either the z test or chi-square test. Considering the individual consecutive year tests in Table 2, the largest z statistics and chi-square statistics occur in the most recent 10 years, when the number of international funds increased to exceed 100 funds. Tables 3–5 show the analogous tests with successive performance lagged by 2, 3, and 4 years. None of the tests statistics for 2-year lags (z = 1.49 and c2 = 2.24 in Table 3), 3-year lags (z = 0.94 and c2 = 0.78 in Table 4), and 4-year lags (z = 1.02 and c2 = 0.91 in Table 5) are statistically significant at any meaningful probability level. Table 6 International return tables summary of combined results Year
Total New WW WL LW LL funds funds (a) (b) (c) (d)
Consecutive 1791 Two-year lag 1384 Three-year lag 1048 Four-year lag 854
496 899 1186 1415
511 343 267 228
383 353 249 216
384 352 249 214
485 308 261 176
Winner Loser Cross z Chi– gone – gone product ratio S.D. Statistics square 7 8 6 5
21 20 16 15
1.69 0.85 1.12 0.87
0.10 0.11 0.12 0.14
5.43 1.49 0.94 1.02
29.60 2.11 0.78 0.91
This table shows combined for all lag periods. Performance persistence is statistically significant only for the 1-year lag periods.
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The results for all lag periods are summarized in Table 6. WWs and LLs exceed 50% only for the 1-year lag periods, and the result are statistically significant. For the 2-year lag period, the 3-year lag period, and the 4-year lag period, WW and LL combined percentages are 47%, 50%, and 47%, respectively. (Recall that there are a few funds that ceased operations to that WW + WL and LW + LL may sum to less than 100%, and WL may not equal LW.) It should be noted that the approach that is applied in this study makes it more difficult for a test statistic to be significant, although the methodology probably minimizes survivorship bias. The significance of the persistence test results are consistent for both the z test and the chi-square test for 1-, 2-, 3-, and 4-year lag periods. 4.2. WL returns Table 7 contrasts average return results for the top 10 ‘‘winners’’ versus the bottom 10 ‘‘losers.’’ The average returns for the 10 ‘‘winners’’ for the previous period are contrasted with average returns for previous period 10 ‘‘losers’’ for each year. ‘‘Winners’’ for period t are defined as the 10 funds with the highest returns in period t 1. ‘‘Losers’’ in period t are the 10 funds with the lowest returns in period t 1. When there are fewer than 20 funds operating in a particular year, there will be some funds that appear within both the ‘‘winners’’ and ‘‘losers’’ lists. The t statistic, 0.27, is computed to test the hypothesis that average returns for ‘‘winners’’ equal average returns for the ‘‘losers.’’ The hypothesis cannot be rejected. There is no significant difference in the two extreme groups of average returns at any meaningful level of significance. It should be noted that because a fund is classified as a winner in the previous period does not mean it will have a high return or rank above the average in any future period. The result in Table 7, comparing higher return funds with lower return funds, enhances the conclusions summarized in Table 6. High return funds are not able to maintain their position among winners for very long. The average returns for previous ‘‘winners’’ do not remain above the mean return for ‘‘losers.’’ Note in the far right hand column of Table 7 that the average returns for ‘‘winners’’ is 2.70% above the average for all ‘‘losers’’ (16.14 vs. 13.44). The lack of significance for the difference is because the standard deviation of the differences is above 10; the differences have a high degree of variability across the 20-year time horizon. A remaining question is whether the same results would be observed between the highest and lowest returns funds for another data set. Tests comparable to the test performed on the existing database in Table 7 are performed using the international mutual funds data provided by the Morningstar Principia Plus CD for the 10-year period 1988–1997. The Morningstar database contains return data for a total of 449 international mutual funds, of which 43 have 10-year returns data. In this case, a simple trading rule was tested that compared the year-later returns of the top 10 winners in the previous period with the bottom 10 losers in the previous period. This, in effect, tests the rule of buying the previous year’s 10 best-performing funds, holding them for 1 year, and replacing with the current year’s top performing funds. Results of this test are shown in Table 8. Over the nine subsequent 1-year holding periods, the top 10 funds earned an average of 9.63% per year, while the bottom 10 earned an average of 6.74%,
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Table 7 WL returns 1978 – 1996 Year 1978
1979
1980 1981
1982 1983
1984
1985
Number 12 13 13 15 20 22 26 34 of funds Average return 16.68 22.20 30.67 0.57 10.94 24.69 3.36 37.93 (winners) Average return 20.64 26.92 30.15 4.27 8.42 30.84 7.93 40.57 (losers) Difference 3.96 4.72 0.52 3.70 2.52 6.15 4.57 2.64 Standard deviation of difference t-statistic
1986 1987 1988 1989 42
66
94
110
46.96 16.71 17.42
25.34
31.69
19.85
4.48 16.89
15.27 12.23
0.53
5.49
This table compares the subsequent year returns of the 10 highest returning winners with the subsequent year return of the 10 lowest returning losers in each year for all funds in the 1977 – 1996 database.
a difference of nearly 3% per year. This difference, however, is not statistically significant at any meaningful probability level due to the very large standard deviation of the differences. Winners outperformed losers in six of the nine holding periods and underperformed them in three periods.
5. Summary and conclusions This study presents the results of an analysis of international mutual fund persistence for a large number of funds and an extensive test period. The authors are not aware of any other tests of persistence of returns for international equity funds. This study applies the ‘‘winner– winner, winner–loser’’ methodology developed by Brown and Goetzmann, Goetzmann and Ibbotson, and Malkiel to test for short-term performance persistence in international equity mutual funds over the 20-year period from 1977 to 1996. When new funds begin operating, they are included in the analysis so that a funds’ persistence is ranked relative to all funds — new and continuing — operating in each time period. This appears to make it more difficult to find statistical significance of persistence. Survivorship bias is minimal in this study because each new fund is added to the database, merging funds continue to be included and funds that cease to exist are separated for the analysis. The only bias is that, if any funds closed and did not merge with an existing fund, that fund would not have returns to be included. There are two tests — a z test and a chi-square test — to examine the significance of return persistence. Statistical z tests and chi-square tests of short-term performance show strong persistence of above-mean performance for 1-year periods. This is a similar result to the authors’ finding of short-term persistence for US domestic mutual funds. The analogous tests are applied to successive performance lagged by 2, 3, and 4 years. None of the test statistics for 2-, 3-, or 4-year lags are statistically significant at any meaningful probability level. These results are enhanced by the tests of ‘‘winners’’ versus ‘‘losers’’ across the 20-
W.G. Droms, D.A. Walker / Global Finance Journal 12 (2001) 237–248
1990 123
1991
1992
147
170
1993
1994
222
271
1995
1996
383
473
247
Period average
14.97
9.86
6.70
52.10
18.05
3.70
20.59
16.14
15.33
9.56
13.94
28.42
2.03
1.90
19.68
13.44
0.36
0.30
20.64
23.68
20.08
5.60
0.91
2.70 10.06 0.27
year period and across a 10-year period using the Morningstar Principia Plus database. This leads to the conclusion that international equity mutual funds exhibit strong performance persistence for short terms (1-year holding periods), but persistence generally fades after the first year. These results are generally consistent with results found by other researchers using this methodology.
Acknowledgments The authors would like to acknowledge the research assistance of Jay Jacobs, Aminul Haque, and Harry Harvin. This research was supported in part by the McDonough School of
Table 8 Morningstar winner/loser returns 1988 – 1997 Year 1989 Number of funds 43 Average return 24.92 (winner) Average return (loser) 17.98 Difference 6.94 Standard deviation of difference t Statistic
1990
1991
1992
1993
1994
1995
1996
1997
Period average
51 61 11.61 13.21
79 119 165 268 346 449 1.36 43.99 7.02 7.81 18.24 1.52 9.63
14.58 2.98
7.75 6.39
9.02 4.19
32.21 11.78
0.83 6.19
13.08 5.27
4.80 13.45
6.73 6.74 8.25 2.89 7.86 0.37
This table compares the subsequent year returns of the 10 highest returning winners with the subsequent year return of the lowest returning losers in each year for the international funds in the Morningstar database over the 1988 – 1997 period.
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Business and the Capital Markets Research Center at Georgetown University. Presented to the EFMA/FMA International meetings, Lisbon, Portugal, June 1998.
References Brown, S. J., & Goetzmann, W. N. (1995). Performance persistence. Journal of Finance, 50, 679 – 698. Carhart, M. M. (1997). On persistence in mutual fund performance. Journal of Finance, 52, 57 – 82. Cumby, R. E., & Glen, J. D. (1990). Evaluating the performance of international mutual funds. Journal of Finance, 45, 497 – 521. Droms, W. G., & Walker, D. A. (1994). Investment performance of international mutual funds. Journal of Financial Research, 17, 1 – 14. Elton, E. J., Gruber, M. J., & Blake, C. R. (1996). The persistence of risk-adjusted mutual fund performance. Journal of Business, 69, 133 – 157. Eun, C. S., Kolodny, R., & Resnick, B. G. (1991). US-based international mutual funds: a performance evaluation. Journal of Portfolio Management, 17, 88 – 94. Goetzmann, W. N., & Ibbotson, R. G. (1994). Do winners repeat? Patterns in mutual fund performance. Journal of Portfolio Management, 20, 9 – 18. Grinblatt, M., & Titman, S. (1992). The persistence of mutual fund performance. Journal of Finance, 47, 1977 – 1984. Hendricks, D., Patel, J., & Zeckhauser, R. (1993). Hot hands in mutual funds: short-run persistence of relative performance, 1974 – 88. Journal of Finance, 48, 93 – 130. Malkiel, B. G. (1995). Returns from investing in equity equal funds 1971 to 1991. Journal of Finance, 50 (June). Wiesenberger Investment Companies Service (1978 – 1997). Investment companies. New York: Warren, Gorham and Lamont.
Performance persistence of international mutual funds William G. Droms*, David A. Walker McDonough School of Business, Georgetown University, Washington, DC 20057, USA Received 16 February 1999; received in revised form 23 March 2000; accepted 13 March 2001
Abstract This study applies the ‘‘winner– winner, winner – loser’’ methodology developed by Brown and Goetzmann, Goetzmann and Ibbotson, and Malkiel to test for short-term performance persistence in international equity mutual funds over the 20-year period from 1977 to 1996. Persistence tests are applied to a database consisting of all international equity funds in existence during this period, varying from a low of 11 (1977) to a high of 473 (1996) funds, reflecting the extremely rapid growth of this asset class over the last 20 years. The authors are not aware of any other persistence studies of international equity funds. The results show statistically significant performance persistence for 1-year holding periods, but no persistence for 2-, 3- or 4-year periods. For 1-year periods, overall, performance persistence is statistically significant at the .001 level. This leads to the conclusion that international equity mutual funds exhibit strong performance persistence for short-term (1-year holding periods), but persistence generally fades after the first year. These results are generally consistent with results found by other researchers using this methodology. Survivorship bias is a concern in virtually all time series studies of mutual fund returns. This bias is minimal in this study because each new fund is added to the database, merging funds continue to be included and adjustments are made for funds that cease operations. The only bias is that if any fund closed and did not merge with an existing fund, that fund would not have returns to be included for the future periods. Only 28 funds ceased operations over the 20-year period during which 490 new funds were introduced. D 2001 Elsevier Science Inc. All rights reserved. Keywords: Mutual funds; Mutual fund performance; International mutual funds
* Corresponding author. Tel.: +1-202-687-3820. E-mail addresses: [email protected] (W.G. Droms); [email protected] (D.A. Walker). 1044-0283/01/$ – see front matter D 2001 Elsevier Science Inc. All rights reserved. PII: S 1 0 4 4 - 0 2 8 3 ( 0 1 ) 0 0 0 3 0 - 8
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1. Introduction This study provides an analysis of the persistence of international equity mutual funds. A fund is defined to ‘‘persist’’ if, for consecutive time periods, it has returns above the median, relative to comparable funds. Studies by Brown and Goetzmann (1995), Carhart (1997), Elton, Gruber, and Blake (1996), Goetzmann and Ibbotson (1994), Grinblatt and Titman (1992), Hendricks, Patel, and Zeckhauser (1993), and Malkiel (1995) have tested the persistence of mutual fund total returns over time periods ranging form 10 to 31 years. Grinblatt and Titman find evidence that differences in performance between funds persist over time and that this persistence is consistent with the ability of fund managers to earn abnormal returns. Hendricks, Patel, and Zeckhauser find that the relative performance of no-load, growthoriented mutual funds persists in the near term, with the strongest evidence for a 1-year time horizon. Goetzmann and Ibbotson find strong evidence that past mutual fund performance predicts future performance. Their data suggest that both ‘‘winners’’(funds with returns above the median) and ‘‘losers’’ (funds with returns below the median) are likely to repeat, even when performance is adjusted for relative risk. Brown and Goetzmann find that relative risk-adjusted performance of mutual funds persists but that persistence is mostly due to funds that lag the S&P 500; the implication of their results for investors is that the persistence phenomenon is a useful indicator of which funds to avoid. Malkiel finds that funds in the aggregate have underperformed benchmark portfolios even before deduction of expenses and that while considerable performance persistence existed during the 1970s, there was no consistency of performance during the 1980s. Elton, Gruber, and Blake find that risk-adjusted performance tends to persist; funds that did well in the past tend to do well in the future. Using Jensen’s alpha as a measure of riskadjusted performance, their paper shows that, primarily, 1-year alphas provide information about future performance and that portfolios based on past performance significantly outperform equally weighted portfolios of funds. Carhart develops a 31-year data sample free of survivor bias and demonstrates that common factors in stock returns and investment expenses almost completely explain persistence in equity mutual funds’ mean and risk-adjusted returns; his results do not support the existence of skilled or informed mutual fund managers. These studies focus on US domestic mutual funds. The current study examines the persistence of international mutual funds. The null hypothesis is that there is no persistence between time periods. Whether or not new funds enter the market, winners in period t are examined to test whether they are winners in period t + j, for j = 1, 2, 3, 4. Cumby and Glen (1990), Droms and Walker (1994), and Eun, Kolodny, and Resnick (1991) provide performance studies of international mutual funds, but none of these studies test for persistence. This study of persistence examines more mutual funds over a longer period of time than previous studies. The results suggest that mutual fund performance does not persist over long periods of time but does exhibit persistence between consecutive time periods. The results suggest that findings of persistence of returns are sensitive to the length of time included in the analysis.
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2. Methodology 2.1. Research issue This study applies the successive ‘‘winner–winner, winner–loser’’ methodology applied by Brown and Goetzmann, Gotezmann and Ibbotson, and Malkiel. Funds are rank-ordered by 1-year total returns with 50% of the funds with the highest returns labeled ‘‘winners’’ and 50% of the funds with the lowest returns labeled ‘‘losers.’’ Funds that ceased operations in the subsequent year are identified as ‘‘gone.’’ Two-by-three tables are constructed to identify funds that are ‘‘winners’’ and ‘‘losers’’ in 1 year and then ‘‘winners,’’ ‘‘losers,’’ or ‘‘gone’’ in successive years. Statistical significance tests (z scores) are employed following the procedure described by Brown and Goetzmann. Chi-square tests of significance also are calculated. 2.2. Approach To examine the persistence of returns for N funds, the returns are rank-ordered from the lowest return R1 to the highest return RN so that the returns form the vector R ¼ ½R1 ; . . . ; R0:5N ; R0:5N þ1 ; . . . ; RN The first half of the returns — R1, . . ., R0.5N — defines the funds that are ‘‘losers’’ and the second half of the returns — R0.5N + 1,...RN — designates the funds that are called the ‘‘winners.’’ Funds with returns equal to the median are also called ‘‘winners.’’ Let L ¼ ½R1 ; . . . ; R0:5N and W
¼ ½R0:5N þ1 ; . . . ; RN :
If only these same funds operate for the next period, the definition of persistence is quite simple. In that case, each element of L either remains in the lower half of the returns or shifts to the upper half of the returns. Likewise, each element of W remains a member of W or does not have returns among the top half of the rank ordering. If a fund is in L for consecutive periods, it is defined as a loser–loser (LL). If a fund remains in the top half of the returns, it is a winner–winner (WW). A fund that shifts from L to W is a loser–winner (LW) and a fund that shifts from W to L is a winner–loser (WL). Funds that cease operations that were ‘‘winners’’ (losers) during the previous period are designated as winner–gone (WG) or loser–gone (LG). In matrix form, the path can be described as
period t
winner loser
period t + 1 winner WW LW
loser WL LL
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Table 1 International mutual fund return tables mean, median, and EAFE returns (%): 1977 – 1996 Year Number of funds New funds Mean Median EAFE returns
1977
1978
1979
1980
1981
1982
1983
1984
1985
11
12 1 23.07 20.25 32.59
13 1 19.75 25.30 4.76
13 0 33.12 26.90 22.56
15 2 0.10 0.50 2.27
20 5 10.91 10.30 1.90
22 2 27.16 28.45 23.69
26 4 4.68 2.90 7.37
34 9 39.86 38.95 56.19
1.87 0.20 18.04
This table shows the total number of funds in the sample each year, the number of new funds introduced each year, the mean and median returns on the funds in the sample, and the comparable return on the Europe, Australia, and Far East Index (EAFE) for each year. There were 11 international funds in existence in 1977. From 1978 – 1996, 490 new funds were added and 28 funds ceased operations, resulting in a sample size of 473 funds in 1996.
The classification is somewhat more complex for two reasons. Between periods t and t + 1, there could be an increasing number of funds or funds that could close. Suppose M new funds are operating in period t + 1, then M + N funds are to be ranked. If K funds close, M + N K funds are to be ranked. After the M + N K funds are ranked, the winners from period t are identified as winners again or losers and the losers from period t are identified as repeat losers or winners. The funds that are new in period t + 1 are ranked, but the matrix path will include only the funds that operate in the consecutive periods.
3. Data Annual mutual fund data are collected for a total of 529 international equity mutual funds that were in operation during the 20-year period from 1977 through 1996. There were only a total of 28 funds that ceased operations over the 20-year period, while 490 new funds were introduced. The data set provides annual data on total returns from the annual Wiesenberger Investment Companies Service (1978–1997). Returns are measured as the percentage annualized total rate of return for the fund (treating all dividends as reinvested), net of fees and expenses and before load charges, where applicable. 3.1. Characteristics Table 1 provides the general characteristics of the data set. The number of international equity funds in the first year (1977) was only 11, and the number increased gradually until 1986. The number more than doubled over the next two years and increased steadily until a large number of new funds began operating each year after 1990. The mean and median returns are presented for all funds operating for each year. For comparison purposes, the return on the Morgan Stanley EAFE also is presented.
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1986 42 8 42.21 42.45 69.45
241
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
68 25 9.82 7.65 24.65
94 28 15.24 14.40 28.26
110 15 22.11 20.55 10.55
123 14 11.69 11.30 23.44
147 33 14.13 13.00 12.13
170 30 3.00 2.80 12.77
222 54 38.58 34.80 32.56
275 58 2.64 2.00 7.77
384 115 8.29 9.65 11.21
473 92 13.51 13.40 6.04
For six of the last 10 years, the mean of the international mutual fund returns is larger than the EAFE returns, and the average return for the international funds was 10.44% versus
Table 2 International return persistence: 1-year lag Year
Total New WW LW LL funds funds (a) (c) (d)
1977 – 1978 11 1978 – 1979 12 1979 – 1980 13 1980 – 1981 13 1981 – 1982 15 1982 – 1983 20 1983 – 1984 22 1984 – 1985 26 1985 – 1986 34 1986 – 1987 42 1987 – 1988 67 1988 – 1989 95 1989 – 1990 110 1990 – 1991 123 1991 – 1992 147 1992 – 1993 170 1993 – 1994 218 1994 – 1995 270 1995 – 1996 383 Total 1791
1 1 0 2 5 2 4 9 8 25 28 15 14 33 30 54 58 115 92 496
2 1 2 3 4 3 6 4 13 12 17 33 29 33 52 43 44 85 125 511
WL Winner Loser Cross z Chi(b) – gone – gone product ratio S.D. Statistic square
3 2 4 5 1 5 5 1 5 5 1 4 4 3 4 7 3 7 4 7 5 8 5 9 3 13 5 8 13 9 19 14 17 17 29 16 25 29 26 25 31 25 14 53 21 37 46 42 63 40 66 65 71 47 67 123 66 384 485 383
0 0 0 0 0 0 0 0 0 0 0 0 0 4 1 0 0 1 1 7
0 0 0 0 0 0 0 0 0 0 0 0 1 5 6 2 5 1 1 21
0.33 0.04 0.08 0.15 0.75 0.18 2.10 0.28 11.27 2.17 0.74 3.52 1.29 1.64 9.37 1.27 0.42 1.98 3.48 1.69
1.26 1.55 1.38 1.34 1.04 0.98 0.87 0.83 0.83 0.63 0.49 0.43 0.38 0.38 0.40 0.31 0.28 0.25 0.21 0.10
0.87 2.08 1.83 1.42 0.28 1.74 0.85 1.55 2.92 1.23 0.62 2.92 0.67 1.31 5.65 0.78 3.06 2.72 5.80 5.43
0.08 3.00 2.01 0.85 0.06 1.80 0.18 1.39 7.69 0.86 0.14 7.61 0.23 1.32 35.11 0.39 8.89 6.88 33.68 29.60
This table shows performance persistence with a 1-year lag. Winners and losers are ranked relative to the median fund in Year 1 and reranked in Year 2. Winners are funds with returns above the median and loser are funds with returns below the median. Funds ceasing operations are identified as gone.
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Table 3 International return persistence: 2-year lag Year
Total New WW WL LW LL funds funds (a) (b) (c) (d)
1977 – 1979 11 1978 – 1980 12 1979 – 1981 13 1980 – 1982 13 1981 – 1983 15 1982 – 1984 20 1983 – 1985 22 1984 – 1986 26 1985 – 1987 34 1986 – 1988 42 1987 – 1989 67 1988 – 1990 95 1989 – 1991 109 1990 – 1992 114 1991 – 1993 140 1992 – 1994 166 1993 – 1995 216 1994 – 1996 269 Total 1384
2 1 2 7 7 6 13 17 33 53 43 29 47 63 84 112 173 207 899
4 4 4 3 4 6 5 3 7 17 18 20 32 27 35 31 49 74 343
2 2 3 2 3 3 3 4 2 4 4 2 4 3 4 4 3 7 6 5 6 9 8 5 11 8 8 4 9 12 16 20 13 29 25 20 21 19 29 27 18 35 38 31 34 53 49 28 61 73 31 59 68 66 353 352 308
Winner Loser Cross z Chi– gone – gone product ratio S.D. Statistics square 0 0 0 0 0 0 0 1 0 0 0 0 2 4 0 0 1 0 8
0 0 0 0 0 0 0 0 0 0 0 1 6 3 2 5 1 2 20
3.00 2.00 0.67 0.38 1.33 3.50 1.00 0.21 0.64 5.67 0.73 0.55 2.33 1.94 1.01 0.33 0.34 1.22 0.85
1.26 1.19 1.15 1.15 1.04 0.94 0.86 0.88 0.70 0.71 0.49 0.42 0.41 0.40 0.34 0.33 0.29 0.25 0.11
0.87 0.58 0.35 0.85 0.28 1.33 0.00 1.79 0.65 2.45 0.63 1.42 2.07 1.67 0.03 3.35 3.74 0.80 1.49
0.08 0.00 0.05 0.09 0.06 0.81 0.18 2.10 0.09 4.95 0.15 1.50 3.78 2.31 0.02 10.73 13.43 0.46 2.11
This table shows performance persistence with a 2-year lag. Winners and losers are ranked relative to the median fund in Year 1 and reranked in Year 3. Winners are funds with returns above the median and loser are funds with returns below the median. Funds ceasing operations are identified as gone.
9.70% average EAFE returns. The standard deviation of the international fund returns (13.49) also is smaller than the standard deviation of the EAFE index (16.49). 3.2. Survivorship bias One of the key issues to be considered for every time series analysis of mutual fund returns is potential survivor bias. This bias is minimal in this study because each new fund is added to the database and merging funds continue to be included. The only bias is that, if any funds closed and did not merge with an existing fund, that fund would not have returns to be included for the year in which operations ceased. Only 28 funds ceased operations while 490 new funds were added. If a fund in the database merged into another fund also in the database, the surviving fund is carried forward and the acquired fund is dropped entirely. If a fund in the database merged into a fund not in the database of if the fund closed, the fund is dropped. Complete data were then assembled for all funds for which the data had been published for the entire 20-year period of 1977–1996. For each test of persistence between periods, there are approximately three times as many previous ‘‘losers’’ that are ‘‘gone’’ than previous ‘‘winners’’ that are ‘‘gone.’’ The authors believe that including all operating funds (new and old) in the returns
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Table 4 International return persistence: 3-year lag Year
Total New WW WL LW LL funds funds (a) (b) (c) (d)
1977 – 1980 11 1978 – 1981 12 1979 – 1982 10 1980 – 1983 12 1981 – 1984 13 1982 – 1985 23 1983 – 1986 20 1984 – 1987 22 1985 – 1988 29 1986 – 1989 46 1987 – 1990 69 1988 – 1991 87 1989 – 1992 110 1990 – 1993 107 1991 – 1994 138 1992 – 1995 132 1993 – 1996 207 Total 1048
2 3 7 9 11 15 21 42 61 68 57 62 77 117 142 227 265 1186
4 4 3 3 4 6 5 3 7 17 17 20 32 27 35 31 49 267
2 2 3 2 3 3 1 1 5 3 2 4 2 1 6 7 7 3 4 3 8 6 6 7 6 11 5 8 10 11 18 17 16 21 17 26 29 17 25 26 23 29 38 33 27 24 37 38 52 59 45 249 249 261
Winner Loser Cross z Chi– gone – gone product ratio S.D. Statistics square 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 0 1 6
0 0 0 0 0 0 0 0 0 0 0 2 6 1 4 2 1 16
3.00 2.00 15.00 2.00 12.00 0.37 3.33 0.58 0.53 2.34 0.89 1.46 1.62 1.31 0.75 1.33 0.72 1.12
1.26 1.19 1.59 1.19 1.38 0.89 0.95 0.90 0.77 0.61 0.49 0.44 0.41 0.39 0.35 0.36 0.28 0.12
0.87 0.58 1.70 0.58 1.79 1.13 1.26 0.60 0.82 1.39 0.24 0.85 1.19 0.69 0.81 0.79 1.18 0.94
0.08 0.00 1.41 0.00 1.86 0.52 0.68 0.03 0.19 1.21 0.00 0.41 1.03 0.24 0.41 0.38 1.09 0.78
This table shows performance persistence with a 3-year lag. Winners and losers are ranked relative to the median fund in Year 1 and reranked in Year 4. Winners are funds with returns above the median and losers are funds with returns below the median. Funds ceasing operations are identified as gone.
ranking in each period and separating funds that did not continue operations(gone) avoids virtually all of the potential survivor bias.
4. Results 4.1. Persistence Tables 2–5 present the results of persistence tests. Table 2 provides the tests for persistence between consecutive periods: t to t + 1. Tables 3, 4, and 5 provide the tests between periods t and t + 2 (2-year lag), t and t + 3 (3-year lag), and t and t + 4 (4-year lag), respectively. The combined results for each of the lag assumptions appear at the bottom of the tables. There are two tests statistics to examine the significance of persistence of returns. One is a z statistic, which is distributed normally with a zero mean and a standard deviation of 1.0. The second test statistic is a chi-square. If the results are strong and highly convincing for each hypothesis, the results of the z test and the Chi-square test will be consistent. This is the case for each test at the bottom of Tables 2–5, which are summarized in Table 6. Table 2 shows that combined results for the 1-year lag period are highly significant and demonstrate positive performance persistence. Fifty-seven percent of all winners in Year 1 are
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Table 5 International return persistence: 4-year lag Year
Total New WW WL LW LL funds funds (a) (b) (c) (d)
Winner Loser Cross z Chi– gone – gone product ratio S.D. Statistics square
1977 – 1981 1978 – 1982 1979 – 1983 1980 – 1984 1981 – 1985 1982 – 1986 1983 – 1987 1984 – 1988 1985 – 1989 1986 – 1990 1987 – 1991 1988 – 1992 1989 – 1993 1990 – 1994 1991 – 1995 1992 – 1996 Total
11 12 13 13 15 20 22 25 34 42 66 91 94 103 132 161 854
0 0 0 0 0 0 0 0 0 1 0 1 1 1 0 1 5
4 8 9 13 20 23 46 70 76 82 90 92 131 175 257 319 1415
3 1 2 3 2 2 5 8 8 8 14 17 22 27 51 55 228
3 3 2 5 5 1 5 4 2 4 4 2 6 6 1 8 8 2 6 6 5 4 11 2 10 10 6 12 12 9 19 18 14 30 18 19 29 22 19 25 22 24 21 30 28 29 35 40 216 214 176
0 0 0 0 0 0 0 0 0 0 1 6 1 4 2 1 15
0.67 0.04 0.20 0.38 0.06 0.06 0.69 0.36 0.48 0.50 0.57 0.60 0.66 1.18 2.27 2.17 0.87
1.22 1.55 1.20 1.15 1.35 1.12 0.86 0.98 0.70 0.63 0.50 0.45 0.42 0.41 0.37 0.33 0.14
0.33 2.08 1.34 0.85 2.13 2.48 0.43 1.03 1.05 1.09 1.11 1.15 1.00 0.40 2.22 2.37 1.02
0.08 3.00 0.67 0.09 3.36 5.00 0.00 0.34 0.50 0.62 0.76 0.90 0.64 0.04 4.27 5.02 0.91
This table shows performance persistence with a 4-year lag. Winners and losers are ranked relative to the median fund in Year 1 and reranked in Year 5. Winners are funds with returns above the median and losers are funds with returns below the median. Funds ceasing operations are identified as gone.
winners in Year 2, 511 (WW) of 894 (WW + WL); 56% of all losers in Year 1 are losers in Year 2, 485 (LL) of 869 (LL + LW) and this difference is statistically significant at the .001 probability level applying either the z test or chi-square test. Considering the individual consecutive year tests in Table 2, the largest z statistics and chi-square statistics occur in the most recent 10 years, when the number of international funds increased to exceed 100 funds. Tables 3–5 show the analogous tests with successive performance lagged by 2, 3, and 4 years. None of the tests statistics for 2-year lags (z = 1.49 and c2 = 2.24 in Table 3), 3-year lags (z = 0.94 and c2 = 0.78 in Table 4), and 4-year lags (z = 1.02 and c2 = 0.91 in Table 5) are statistically significant at any meaningful probability level. Table 6 International return tables summary of combined results Year
Total New WW WL LW LL funds funds (a) (b) (c) (d)
Consecutive 1791 Two-year lag 1384 Three-year lag 1048 Four-year lag 854
496 899 1186 1415
511 343 267 228
383 353 249 216
384 352 249 214
485 308 261 176
Winner Loser Cross z Chi– gone – gone product ratio S.D. Statistics square 7 8 6 5
21 20 16 15
1.69 0.85 1.12 0.87
0.10 0.11 0.12 0.14
5.43 1.49 0.94 1.02
29.60 2.11 0.78 0.91
This table shows combined for all lag periods. Performance persistence is statistically significant only for the 1-year lag periods.
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The results for all lag periods are summarized in Table 6. WWs and LLs exceed 50% only for the 1-year lag periods, and the result are statistically significant. For the 2-year lag period, the 3-year lag period, and the 4-year lag period, WW and LL combined percentages are 47%, 50%, and 47%, respectively. (Recall that there are a few funds that ceased operations to that WW + WL and LW + LL may sum to less than 100%, and WL may not equal LW.) It should be noted that the approach that is applied in this study makes it more difficult for a test statistic to be significant, although the methodology probably minimizes survivorship bias. The significance of the persistence test results are consistent for both the z test and the chi-square test for 1-, 2-, 3-, and 4-year lag periods. 4.2. WL returns Table 7 contrasts average return results for the top 10 ‘‘winners’’ versus the bottom 10 ‘‘losers.’’ The average returns for the 10 ‘‘winners’’ for the previous period are contrasted with average returns for previous period 10 ‘‘losers’’ for each year. ‘‘Winners’’ for period t are defined as the 10 funds with the highest returns in period t 1. ‘‘Losers’’ in period t are the 10 funds with the lowest returns in period t 1. When there are fewer than 20 funds operating in a particular year, there will be some funds that appear within both the ‘‘winners’’ and ‘‘losers’’ lists. The t statistic, 0.27, is computed to test the hypothesis that average returns for ‘‘winners’’ equal average returns for the ‘‘losers.’’ The hypothesis cannot be rejected. There is no significant difference in the two extreme groups of average returns at any meaningful level of significance. It should be noted that because a fund is classified as a winner in the previous period does not mean it will have a high return or rank above the average in any future period. The result in Table 7, comparing higher return funds with lower return funds, enhances the conclusions summarized in Table 6. High return funds are not able to maintain their position among winners for very long. The average returns for previous ‘‘winners’’ do not remain above the mean return for ‘‘losers.’’ Note in the far right hand column of Table 7 that the average returns for ‘‘winners’’ is 2.70% above the average for all ‘‘losers’’ (16.14 vs. 13.44). The lack of significance for the difference is because the standard deviation of the differences is above 10; the differences have a high degree of variability across the 20-year time horizon. A remaining question is whether the same results would be observed between the highest and lowest returns funds for another data set. Tests comparable to the test performed on the existing database in Table 7 are performed using the international mutual funds data provided by the Morningstar Principia Plus CD for the 10-year period 1988–1997. The Morningstar database contains return data for a total of 449 international mutual funds, of which 43 have 10-year returns data. In this case, a simple trading rule was tested that compared the year-later returns of the top 10 winners in the previous period with the bottom 10 losers in the previous period. This, in effect, tests the rule of buying the previous year’s 10 best-performing funds, holding them for 1 year, and replacing with the current year’s top performing funds. Results of this test are shown in Table 8. Over the nine subsequent 1-year holding periods, the top 10 funds earned an average of 9.63% per year, while the bottom 10 earned an average of 6.74%,
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Table 7 WL returns 1978 – 1996 Year 1978
1979
1980 1981
1982 1983
1984
1985
Number 12 13 13 15 20 22 26 34 of funds Average return 16.68 22.20 30.67 0.57 10.94 24.69 3.36 37.93 (winners) Average return 20.64 26.92 30.15 4.27 8.42 30.84 7.93 40.57 (losers) Difference 3.96 4.72 0.52 3.70 2.52 6.15 4.57 2.64 Standard deviation of difference t-statistic
1986 1987 1988 1989 42
66
94
110
46.96 16.71 17.42
25.34
31.69
19.85
4.48 16.89
15.27 12.23
0.53
5.49
This table compares the subsequent year returns of the 10 highest returning winners with the subsequent year return of the 10 lowest returning losers in each year for all funds in the 1977 – 1996 database.
a difference of nearly 3% per year. This difference, however, is not statistically significant at any meaningful probability level due to the very large standard deviation of the differences. Winners outperformed losers in six of the nine holding periods and underperformed them in three periods.
5. Summary and conclusions This study presents the results of an analysis of international mutual fund persistence for a large number of funds and an extensive test period. The authors are not aware of any other tests of persistence of returns for international equity funds. This study applies the ‘‘winner– winner, winner–loser’’ methodology developed by Brown and Goetzmann, Goetzmann and Ibbotson, and Malkiel to test for short-term performance persistence in international equity mutual funds over the 20-year period from 1977 to 1996. When new funds begin operating, they are included in the analysis so that a funds’ persistence is ranked relative to all funds — new and continuing — operating in each time period. This appears to make it more difficult to find statistical significance of persistence. Survivorship bias is minimal in this study because each new fund is added to the database, merging funds continue to be included and funds that cease to exist are separated for the analysis. The only bias is that, if any funds closed and did not merge with an existing fund, that fund would not have returns to be included. There are two tests — a z test and a chi-square test — to examine the significance of return persistence. Statistical z tests and chi-square tests of short-term performance show strong persistence of above-mean performance for 1-year periods. This is a similar result to the authors’ finding of short-term persistence for US domestic mutual funds. The analogous tests are applied to successive performance lagged by 2, 3, and 4 years. None of the test statistics for 2-, 3-, or 4-year lags are statistically significant at any meaningful probability level. These results are enhanced by the tests of ‘‘winners’’ versus ‘‘losers’’ across the 20-
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1990 123
1991
1992
147
170
1993
1994
222
271
1995
1996
383
473
247
Period average
14.97
9.86
6.70
52.10
18.05
3.70
20.59
16.14
15.33
9.56
13.94
28.42
2.03
1.90
19.68
13.44
0.36
0.30
20.64
23.68
20.08
5.60
0.91
2.70 10.06 0.27
year period and across a 10-year period using the Morningstar Principia Plus database. This leads to the conclusion that international equity mutual funds exhibit strong performance persistence for short terms (1-year holding periods), but persistence generally fades after the first year. These results are generally consistent with results found by other researchers using this methodology.
Acknowledgments The authors would like to acknowledge the research assistance of Jay Jacobs, Aminul Haque, and Harry Harvin. This research was supported in part by the McDonough School of
Table 8 Morningstar winner/loser returns 1988 – 1997 Year 1989 Number of funds 43 Average return 24.92 (winner) Average return (loser) 17.98 Difference 6.94 Standard deviation of difference t Statistic
1990
1991
1992
1993
1994
1995
1996
1997
Period average
51 61 11.61 13.21
79 119 165 268 346 449 1.36 43.99 7.02 7.81 18.24 1.52 9.63
14.58 2.98
7.75 6.39
9.02 4.19
32.21 11.78
0.83 6.19
13.08 5.27
4.80 13.45
6.73 6.74 8.25 2.89 7.86 0.37
This table compares the subsequent year returns of the 10 highest returning winners with the subsequent year return of the lowest returning losers in each year for the international funds in the Morningstar database over the 1988 – 1997 period.
248
W.G. Droms, D.A. Walker / Global Finance Journal 12 (2001) 237–248
Business and the Capital Markets Research Center at Georgetown University. Presented to the EFMA/FMA International meetings, Lisbon, Portugal, June 1998.
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