2001•The Journal of FinanceOpen access

Should Investors Avoid All Actively Managed Mutual Funds? A Study in Bayesian Performance Evaluation

Klaas P. Baks, Andrew Metrick, Jessica A. Wachter

Abstract

ABSTRACT This paper analyzes mutual‐fund performance from an investor's perspective. We study the portfolio‐choice problem for a mean‐variance investor choosing among a risk‐free asset, index funds, and actively managed mutual funds. To solve this problem, we employ a Bayesian method of performance evaluation; a key innovation in our approach is the development of a flexible set of prior beliefs about managerial skill. We then apply our methodology to a sample of 1,437 mutual funds. We find that some extremely skeptical prior beliefs nevertheless lead to economically significant allocations to active managers.

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Key concepts: Portfolio, Actuarial science, Sample (material), Business, Mutual fund, Index (typography), Set (abstract data type), Asset (computer security)