The Long-Run Performance of German Stock Mutual Funds

We examine the risk-adjusted performance of open-end mutual funds which invest mainly inGerman stocks. After briefly discussing the institutional environment in which these fundsoperate, we focus on the benchmark problem and the risk adjustment problem. Our data setincludes all German funds sold to the public in 1972, our performance analysis covers the timeperiod 1973 to 1998.In our empirical analysis, we first look at the rates of return of individual funds and at theunweighted average rates of return of all funds in our sample. When we apply the Sharpe andJensen measure to the latter time series in the traditional way, the funds underperform theappropriate benchmarks by approximately 1.5 % per year, which is significant both from thestatistical and the economic perspective. Applying the Sharpe and the Jensen measure in thetraditional way creates a bias from the perspective of long-term investors, because the analysisis based on the arithmetic, not the geometric mean return. To avoid this bias we look, in asecond step, at the returns of investors who risk adjust their fund investments ex-ante by borrowingor lending with the objective, that the future risk of his levered portfolio matches that ofthe chosen benchmark. When we again apply the Sharpe and the Jensen measure to theunweighted average rates of return, the underperformance is reduced by 40 %. For largefunds, on the average, the underperformance is less than for small funds. When we look at thevalue-weighted means of individual fund returns, the underperformance nearly disappears.