Portfolio Management - Essay Example

Similarly, agency models, such as those f Barry and Starks (1984), Starks (1987), Cohen and Starks (1988), and Golec (1988,1992) show that a manger's portfolio risk choices will partly depend upon his or her risk-taking preferences because the volatility f a manager's pay is affected by the portfolio's performance. This study's statistical approach accounts for the fact that performance, risk, and fees are interdependent. Mutual fund performance alone is an important and popular finance topic because funds positive risk-adjusted returns has implications for market efficiency.

Most early studies, such as Jensen (1968) and Sharpe (1966), report that funds provide inferior performance partly because f management fees and other expenses. Recently, however, Ippolito (1989), Lee and Rahman (1990), Grinblatt and Titman (1989,1992), and Hendricks, Patel, and Zeckhauser (1993) show that mutual funds can generate systematic positive risk-adjusted returns. Although Ippolito's sample f funds earned sufficient risk-adjusted returns to cover fees, Elton, Gruber, Das, and Hlavka (1993) question Ippolito's methods and suggest that funds do not exhibit positive risk-adjusted returns.

Whether mutual fund managers produce superior returns is controversial because most studies' funds, sample periods, or performance measures are not comparable. Unlike earlier studies that try to determine if the average risk-adjusted fund performance is positive, this study only requires that a performance measure rank funds appropriately. For example, if longer tenure implies greater human capital which, in turn, generates better performance, then job tenure should be positively related to performance.

This positive relationship can be present even if all funds have negative risk-adjusted performance; long-tenured managers will simply have less negative performance. Earlier studies consider relatively long time periods during which some funds change managers, risk, fees or objective, or liquidate. Here, the cross-sectional data and shorter sample period reduce the degree f fund changes and survivorship bias (Brown, Goetzmann, Ibbotson, & Ross, 1992). The paper is organized as follows. Section I discusses the statistical procedure used to account for simultaneity and defines the study's endogenous and exogenous variables.

Section II describes the data. Section III presents each structural equation along with the results for each equation. Section IV considers the issues f survivorship bias and performance measurement. Section V summarizes the results that have the most significant implications for investors' choice among mutual funds and their managers. Three-Stage Least Squares Many earlier studies, such as Sharpe (1966), Jensen (1968), Friend and Blume (1970), Ippolito (1989), Grinblatt and Titman (1989,1992), Hendricks, Patel, and Zeckhauser (1993) and Elton et al. (1993), compare mutual funds' risk-adjusted performance, as well as other endogenous variables (risk or fees), but ignore the fact that changes in performance, risk, and fees tend to impact each other contemporaneously.

For example, a fund that increases fees will tend to have poorer performance, all else equal. In this case, fees