What determines fund performance persistence? International evidence

• Date: 01 November 2019
• Author: Sofia B. Ramos,António F. Miguel,Aneel Keswani,Miguel A. Ferreira
• DOI: http://doi.org/10.1111/fire.12202
• Published date: 01 November 2019

DOI: 10.1111/fire.12202

ORIGINAL ARTICLE

What determines fund performance persistence?

International evidence

Miguel A. Ferreira1Aneel Keswani2António F. Miguel3

Sofia B. Ramos4

1Nova School of Business and Economics, Lisbon,

Portugal

2Cass Business School - London,London, UK

3Business Research Unit (BRU-IUL),Instituto

Universitário de Lisboa (ISCTE-IUL), Lisboa,

Portugal

4ESSEC Business School, Paris,France

Correspondence

AneelKeswani, 106 Bunhill Row, London EC1Y

8TZ,UK.

Email:a.keswani@city.ac.uk

Fundinginformation

Fundaçãopara a Ciência e Tecnologia,

Grant/AwardNumber: FCT/PTDC/EGE-

GES/112820/2009;Labex MME-DII,

Grant/AwardNumber: ANR-11-LBX-0023-01

Abstract

We study performance persistence across a global sample of equity

mutualfunds from 27 countries. In contrast to the existing U.S.-based

evidence, we find that net performance persistence is present in

the majority of fund industries, suggesting that fund manager skill

is commonplace rather than a rarity. Consistent with the intuition

that more competition in the mutual fund industry makes remaining

a winner fund less likelybut keeping a loser fund at the bottom of the

performance ranks more probable, we show that competitiveness

explains the cross-sectional variation in performance persistence.

KEYWORDS

fund industry competition, manager skill, mutual fund persistence

JEL CLASSIFICATIONS

G15, G23

1INTRODUCTION

Testingfor fund manager persistence is important as it not only tells us if past performance information is helpful in

predictingfuture fund performance, which is of value to investors,1but it also tells us whether fund managers have skill.

Using U.S. fund industry data, several studies test for fund manager performance persistence. For example,Carhart

(1997), Fama and French (2010), and Berk and van Binsbergen (2015) find evidence that there is limited performance

persistence in actively managed equity mutual funds. In addition, they find that what little persistence is present is

concentrated among poor-performing funds.

As the U.S. fund industry is the oldest and by far the largest fund industry (Ferreira, Keswani, Miguel, & Ramos,

2013), it is not clear if the U.S.-based persistence evidence is only applicable to large and developedfund industries or

1Knowledge of whether fund performance is persistent or not is only of value to investors if there are funds with both positive and negativeperformance,

if there is a substantial difference in terms of performance across funds and if there are top funds that create value. Our findings show that there are funds

withboth positive and negative performance. Furthermore they show that there is not only a statistically significant difference in the performance of top and

bottomfunds but also that top funds create value in most countries.

Financial Review.2019;54:679–708. wileyonlinelibrary.com/journal/fire c

2019 The Eastern Finance Association 679

680 FERREIRA ET AL.

can be applied universally.2To address this, we test for persistence using a global sample of mutual fund industries from

27 countries. This sample contains many fund industries with characteristics that are very different from those of the

U.S. fund industry and therefore allow us to determine if the U.S.-based evidence onperformance persistence is valid

for other countries. The additional advantage of using a large cross-section of countries to measure persistence is that

it permits us to analyze which fund industry characteristics influence industry-levelpersistence. While there are many

studies that test for performance persistence, there are few studies that try to explain what determines persistence.

We employ two methods to measure fund persistence in net performance. The first uses a regression-based

approach and involves regressing fund performance in a given year on lagged performance (together with other con-

trols that determine current fund performance) and using the coefficient on lagged performance to measure persis-

tence. The second method, which we label the performance gap approach, involves sorting funds in a given year on

lagged performance and calculating whether there is a statistically significant performance gap in this period between

previous period winners and losers.3When we run these tests, we find that statistically significant persistence is

present in the majority of countries in our sample. We then investigate if persistence is the result of persistence in

the performance of the best managers or the worst managers. Todetermine this, we change our regression approach

byallowing the coefficient on lagged performance to vary if a fund is a winner or a loser in the prior year. We do likewise

for our performance gap measure, conditioning it on the level of performance in the prior year.Our results show that

persistence around the world is not just due to persistence among poor-performing fund managers, as suggested by

the U.S.-based evidence, but isdue to the persistence of both the worst and best fund managers.

What factors might explain the differences in the levelof persistence observed across fund industries? Two papers

shed light on this. Wahaland Wang (2011) show that fund manager performance diminishes as the level of entry of new

mutual funds into a sector increases.4A similar point is also made by Hoberg, Kumar,and Prabhala (2018). They show

that fund managers who face less competition within their style category are able to generate a more persistent alpha.

Competition is therefore a potential determinant of performance persistence, as it affects how the current worst and

best performing funds will do in the future.

We would expect persistence among poor-performing funds to increase in the presence of greater competition, as

these funds find it more difficult to escape from the bottom tier of performance. In contrast, greater competitivepres-

sures make remaining a top performer more difficult.5Khorana and Servaes (2007) and Khorana,Servaes, and Tufano

(2009) highlight the role of industry structure and developmentas determinants of the level of competition in the fund

industry.They argue that older fund industries have had greater exposure to competitiveforces and are therefore more

competitive. In addition, Khorana and Servaes (2007) show that particularly in less concentrated industries, fund fam-

ilies have less market power and are therefore more competitive. Hence, by using proxiesfor fund industry develop-

ment and concentration,we measure fund industry competitiveness. Our results show that persistence among losers is

greater when fund industries are more competitive, while persistence among winners decreases with competition. We

alsoshow that the documented differences in persistence have an important economic effect for both poor-performing

funds and top-performing funds. Thus, what emerges is that fund industry competition is an important determinant of

performance persistence.6

2The literature has shown that there are economically significant differences in the conduct of mutual funds around the world and that the features of the

U.S.fund industry are not necessarily the same as those of other countries. Differences have been found in size and fees (Khorana, Servaes, & Tufano, 2005;

Khoranaet al., 2009), in the flow-performance sensitivity (Ferreira, Keswani, Miguel, & Ramos, 2012), and in performance (Ferreira et al., 2013).

3In robustness tests, to measure performance persistence, we also use a third method, namely,the Spearman rank correlation between fund performance

measuresin adjacent years.

4Accordingto the industrial organization literature (Cabral, 2017), the level of entry into a sector is a proxy for its competitiveness, and, therefore, Wahaland

Wang’s(2011) paper suggests that competitiveness affects persistence.

5The fact that in the United States, which has the oldest and largest mutual fund industry in the world, performance persistence is largely due to worst

performersseems to corroborate our hypothesis (see, e.g., Carhart, 1997).

6Another plausible hypothesisregarding the link between competition and fund performance is that in less competitive markets, we might expect managers

to be able to generate positive alphas but also have the power to extractrents from shareholders by charging higher fees. While we do find evidence of a

negative correlation between averagefees and measures of mutual fund industry competitiveness, this effect is not strong enough to shift positive average