Risk-Adjusted Performance of Mutual Funds
Mutual funds are now the preferred way for individual investors and many institutions to participate in the capital markets, and their popularity has increased demand for evaluations of fund performance. Many business publications now rank mutual funds according to their performance, and information services exist specifically for this purpose. There is no general agreement, however, about how best to measure and compare fund performance and on what information funds should disclose to investors.
Risk and performance measurement is an active area for academic research and continues to be of vital interest to investors who need to make informed decisions and to mutual fund managers whose compensation is tied to performance. This article describes a number of performance measures. Their common feature is that they all measure funds' returns relative to risk. However, they differ in how they define and measure risk and, consequently, in how they define risk-adjusted performance. The author also compares rankings of a large sample of funds using two popular measures. She finds a surprisingly good agreement between the two measures for both stock and bond funds during the three-year period between 1995 and 1997.