An Investigation into the Performance of Recommended Funds : Do the Managed Funds 'Approved' by Research Companies Outperform the Non Gratae?

In Australia, research companies play an important role in determining the placement of investments in the unit trust sector (analogous to mutual funds in the U.S.) through their ?approved lists? of funds that they consider to be of high quality. Individual investors rely heavily on the advice of financial planners who in turn rely heavily on the research companies? approved lists in recommending funds to their clients. The research companies? role is a controversial one however, with claims of superficial analysis and a concentration of power. Also, the necessity of their monitoring function can be questioned in light of the robust U.S. mutual fund industry which relies on market mechanisms rather than a system of independent ratings. Although investors choose managed funds on the basis of multiple criteria, of ultimate importance is earning the highest return for a given level of risk. In this study we compare the performance of funds approved by research companies to those that did not achieve approved status, the non gratae using returns of five hundred funds in fourteen style categories, 1989 - 1995. Tests of differences between means, individual holding period returns and randomness of ranking reveal that the performance of approved is not significantly different from the non grate. Also, whether investors might use past performance data in lieu of, or in addition to, approval ratings was examined through chi-squared tests of quarterly ranking. Performance persistence was found to be weak and not statistically significant. The study provides important insight into the potential value of monitoring agencies in helping investors identify the best performing funds. The results should be of interest to investors in any country which relies on (or considering instituting) explicit monitoring of fund quality through ratings