Expectations of Active Mutual Fund Performance

We recover a forward-looking distribution of expected abnormal returns (alphas)for active equity mutual funds from analyst ratings. Professional analysts believe thatalphas are dispersed, that the average fund will underperform, and that the largestfunds will outperform. We estimate a rational expectations learning model of fundperformance and confront the model-implied expectations based on fund size, perceivedskill, and fees with analysts' expectations. Analysts and the rational learner respondsimilarly to changes in perceived skill and fees, but in contrast to the rational learner,analysts do not believe in a negative impact of fund size on fund returns. The absenceof such decreasing returns to scale in analysts' expectations and the presence thereofin actual fund returns make it difficult to reconcile analysts' expectations with rationalexpectations, but can help explain the size of the industry together with its poorperformance