The Investment Scientist

In answer to my readers’ response to my survey last year, I will be writing a series of articles about academic research in the realm of finance, focusing on studies that are pertinent to us, the average investor.

Today, I am writing about the most cited research in the Journal of Finance. It’s written by Mark M. Carhart, and titled “On Persistence in Mutual Fund Performance”, published in 1997.

Why should you care?

Well, if the research were able to help us identify a few persistent winners among the more than 10,000 available funds, wouldn’t that make our investment life a lot simpler?  We could hold only the winners and be done with it. Unfortunately, the research did not find any persistent winners.  More precisely, other than a small momentum effect, the research found no evidence that any mutual fund has the ability to consistently outperform the market.

However, the research did find that mutual fund expenses and transaction costs are persistent predictors of underperformance. A 1% increase in expense ratio correlates to a 1.5% decrease in fund performance and a 1% increase in fund turnover results in a 0.95% decrease in fund performance.  

Here are the three expenses or costs that you should especially watch out for.