Explaining the Initial Returns of Mutual Funds

Abstract

Mutual funds that were less than five years old represented approximately 38% of the open-end mutual fund population as of December 31, 1999. The primary research question examines whether the initial returns of mutual funds are biased. The implication of the analysis is that inferences about the management ability of small-cap growth, mid-cap growth, and high-yield bond fund managers are more likely to be overstated for new funds than seasoned funds. The bias associated with new mutual fund returns is shown to be positively related to the size of the fund family and the number of brokerage companies that sell the family's funds. The most likely sources of the new fund return bias estimated during the period 1994–1999 include incubation, favoritism, and higher termination rates of new funds relative to seasoned funds.