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Effects of return expectation on mutual funds’ risk exposures

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Abstract

We use market-wide implied cost of capital to investigate changes in mutual funds’ risk exposures. Our approach is solely based on market information at the respective time and seems natural, as analysts and fund managers possess similar knowledge and skills. Using a sample of 4147 US equity mutual funds, we provide evidence for time-varying risk exposures for all funds, independent of their style and size focus. Furthermore, value (growth) funds reduce their value (momentum) loadings in times of a high expected market risk premium. However, only for small- and mid-cap funds, this beneficial behavior can be attributed to active management. After controlling for time-varying risk factors, all fund types perform equally poorly measured by their alpha.

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Notes

  1. Li et al (2013) show that aggregated implied cost of capital are strongly correlated to the realized excess market returns. Furthermore, the empirical methodology of Dangl and Halling (2012) predicts increasing (decreasing) equity risk premiums in recessions (expansions).

  2. Even though we do not report the estimates, this model is estimated with a time-variant constant in order to avoid a bias in the other estimators as suggested by Ferson et al (2009). Because implied costs of capital are strongly autocorrelated, our standard errors are corrected for heteroskedasticity and autocorrelation of up to 12 lags by the methodology provided by Newey and West (1987).

  3. Best and Byrne (2001) use a similar approach but do use aggregate dividend forecasts and do not look at firm-level data.

  4. For the interconnection between fund managers’ investment decisions and analysts’ recommendations see Franck and Kerl (2014).

  5. A similar approach in categorizing is applied by Becker et al (1999) and Swinkels and Tjong-A-Tjoe (2007).

  6. This is in line with findings of Zhang et al (2009) when we assume that high GDP growth is similar to a low expected market risk premium (see also Figure 1).

  7. This might also explain why Swinkels and Tjong-A-Tjoe (2007) find market timing ability regarding the value and momentum factors but not for the size premium.

  8. We are grateful to an anonymous referee for bringing up this point.

  9. The corresponding regression table can be found in Appendix A.

  10. A more detailed analysis can be found in Appendix B.

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Acknowledgements

We thank two anonymous referees, Patrick Bielstein, Christoph Jäckel, Christoph Kaserer and Katja Mühlhäuser. All errors are our own.

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Authors and Affiliations

  1. Department of Financial Management and Capital Markets, TUM School of Management, Technische Universität München, 80333 Munich, Germany

    Mario Fischer

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  1. Mario Fischer
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  2. Maximilian Overkott
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Correspondence to Mario Fischer.

Appendices

Appendix A

Table A1

Table A1 Conditional Carhart four-factor model including the liquidity factor
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Appendix B

Table B1

Table B1 Contingency table of the expected MRP based on icc and economic indicators
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Fischer, M., Overkott, M. Effects of return expectation on mutual funds’ risk exposures. J Asset Manag 16, 156–169 (2015). https://doi.org/10.1057/jam.2015.15

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