By Aye Soe
- Modern portfolio theory (MPT) states that expectations of returns must be accompanied by risk or variation around the expected return. It assumes that higher risk should be compensated, on average, by higher returns.
- Beyond relative performance of funds, market participants are also interested in the risks taken to achieve those returns. This motivated us to examine the performance of actively managed funds on a risk-adjusted basis.
- Critiques of passive investing often argue that indices are not risk managed, unlike active management. Therefore, our study aims to understand whether actively managed funds are able to generate higher risk-adjusted returns than their corresponding benchmarks.
- We used the standard deviation of monthly returns, over a given period, to define and measure risk. We used net of fees and gross of fees returns in our calculation of risk. Our goal was to establish whether risk or fees affected managers’ relative performance versus the benchmark.
- We used the return/risk ratio to evaluate managers’ risk-adjusted performance. To make our comparison relevant, we also adjusted the returns of the benchmarks used in our analysis by their volatility.
- Our analysis showed that on a risk-adjusted basis, the majority of actively managed domestic and international equity funds underperformed the benchmarks when using net of fees returns. However, when gross of fees returns were used, managers in certain categories outperformed the benchmarks.
- In fixed income, we found that actively managed bond funds outperformed their benchmarks when gross of fees returns were used. The results highlighted that fees negatively affected active bond funds’ performance.