The Failure of Mutual Funds over Long Horizons

It’s common for a mutual fund to outperform its benchmark over a short time horizon – a few years – as happened with Cathie Wood’s ARKK. But new research shows that mutual funds fail dismally when performance is measured over the long horizons that retirement-focused investors face.

While investment decisions can stretch over decades, much of the research on mutual fund performance has examined outperformance over relatively short horizons. Since investors are concerned about long-term outcomes, Hendrik Bessembinder, Michael Cooper and Feng Zhang, authors of the study, “Mutual Fund Performance at Long Horizons,” published in the January 2023 issue of the Journal of Financial Economics, examined the frequency with which individual mutual funds outperformed benchmarks in terms of compound (annualized) returns over various horizons. They began by noting: “The majority of the existing empirical literature focuses on observed monthly returns and constructs performance measures, e.g. Sharpe ratios, alphas, etc. that rely on the conditional or unconditional arithmetic mean of those monthly returns.” Thus, their focus was on the impact of volatility on long-horizon returns.