Mutual Fund Returns: Side-by-Side Mutual Funds vs. Stand-Alone Mutual Funds

February 21st, 2007 by Util

A new academic study entitled “For Better or Worse? Mutual Funds in Side-by-Side Management Relationships with Hedge Funds” by Gjergji Cici, Scott Gibson, and Rabih Moussavvi, published in the Social Science Research Network, concluded the following:

1. “The reported returns of side-by-side mutual funds are significantly less than those of similar mutual funds run by firms that do not also manage hedge funds.”

2. Side-by-side mutual funds get “less of a contribution to performance from IPO underpricing than matched unaffiliated mutual funds.”

According to the findings of this paper, managers who run hedge funds and mutual funds simultaneously are favoring hedge funds when allocating trades and IPOs. Mutual funds run by firms without hedge funds perform better on average. The SEC is aware of the problem and in 2003, issued a report on hedge funds, stating their was a conflict of interest at side-by-side mutual fund companies due to the higher compensation for hedge funds, but has done nothing more. According to the study, on average, side-by-side mutual funds underperformed by 0.043% per month between 1994-2004.

MY ANALYSIS:

This is a depression on return of 0.562%/year on average. This means that if you invested $10,000 on January 1, 1994 in an average stand-along mutual fund (as described in the study), returning 10%/year, you would have $31,384.28 as of December 31, 2006, whereas, if you invested $10,000 on January 1, 1994 in an average side-by-side mutual fund (as described in the study; note: no one side-by-side mutual fund had this performance, it is an average of the depression on returns of all side-by-side mutual funds included in the study and not all side-by-side mutual funds included in the study were shown to favor their hedge funds), returning 9.438%/year, you would have $29,513.98 as of December 31, 2006. This is a difference of $1,870.31, or a total ending value increase of 6.337% over the depressed return from the average side-by-side mutual fund, according to this paper.

12-Year Example of Total Value Difference in Side-by-Side vs. Stand-Alone Mutual Funds

If we extrapolate the findings over a longer time horizon (to look at how it might effect a retirement account), the impact is even larger. If the time horizon is 45 years, instead of 12 years, with the same principle and depression on return as described in the study, the difference between the two accounts would be more than $150,000, or a total ending value increase of 25.912% over the depressed return from the average side-by-side mutual fund.

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45-Year Total Value Difference in Side-by-Side vs. Stand-Along Mutual Funds

Can you afford this depression in return? Note that, if true, this affects all mutual funds, including index mutual funds, so this is a large issue that concerns everyone. To learn more, you can access the original study here. If you have questions as to my methodology, please find click on “Mutual Fund Returns: Side-by-Side Mutual Funds vs. Stand-Alone Mutual Funds” below.

Mutual Fund Returns: Side-by-Side Mutual Funds vs. Stand-Alone Mutual Funds

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Mutual Fund Returns: Side-by-Side Mutual Funds vs. Stand-Alone Mutual Funds