Mutual Funds have been growing in popularity over the past decade, and Professors Steve Ferris and Sterling Yan, of the Department of Finance, have conducted several studies that are of particular interest to both practitioners and finance academics.
Will SEC regulations effectively reduce illegal activity?
In one of their most recent collaborations, Ferris and Yan found that some regulations recently passed by the Securities and Exchange Commission in an attempt to improve mutual fund governance in response to the scandals of last year, might not be as effective as originally anticipated by regulators.
The SEC passed regulations in June 2004 that require the boards of mutual fund to consist of at least three-fourths outside directors and that the chairmen of these boards must also be independent. Outside or independent directors are individuals who are not employees of the mutual fund or do not have any professional relationship or affiliation with the fund. The goal of these regulations was to improve the accountability of the mutual funds to its shareholders. Professors Ferris and Yan found, however, that mutual funds with higher percentages of outside directors or independent chairs do not charge lower fees and aren't less likely to be involved in scandals. They conclude, that these new regulations fail to achieve their intended goals.
"There is no evidence to show that funds with independent chairs charge lower fees or have a greater level of compliance with existing regulations," Ferris said. "These were among the primary arguments in favor of this requirement, so it is not clear what benefits this requirement provides."
Profesors Ferris and Yan note that industry’s opposition against independent chairs emphasizes that such chairs may be less familiar with the fund. The industry also claims that independent chairs can also hurt the fund's earnings performance, may need a larger staff and can require more education about the fund. Another industry argument against requiring outside chairs is that it limits the position to a specific type of individual rather than allowing for selection of the best person.
Ferris and Yan argue that their findings suggest that the SEC should focus on other aspects of board design such as board size, outside director compensation and the number of funds each director oversees. These are the characteristics of board structure that they found to be significantly related to fund fees and the likelihood of fund scandal. Ferris and Yan base their analysis on a study of 448 mutual fund families in 2002, representing nearly 97% of the industry’s total assets for that year..
Because of the current debate over this issue, the research of these MU professors has attracted national attention. The U.S. Chamber of Commerce has requested a copy of their study as well as the SEC. It is clear that this issue remains unresolved, and the scholarship of these department of finance researchers is making important contributions to that debate.
Do managers of focused funds outperform managers of diversified funds?
As mutual funds grow in popularity, the different options investors have before them has increased in number. While diversification is the old rule, focused funds are getting increased attention. In a separate study, however, Professor Yan finds that the managers of focused funds do not necessarily outperform those of diversified ones.
Some believe these focused funds increase value because fund managers can focus on their best ideas. However, focused funds might not outperform diversified funds because their portfolios are less liquid. Consequently, it is more difficult for focused funds to switch in and out of positions.
Yan decided to test this belief to provide insight into the value of active fund management by comparing the performance of focused funds with diversified funds. “We find no evidence that focused funds outperform the diversified funds,” Yan said. “In fact, there is modest evidence that diversified funds actually outperform the focused funds.” Moreover, Yan found that focused funds are more likely to be acquired or liquidated, which is costly for investors in the fund.
This research has implications for both academics and for practitioners, which is why Yan enjoys performing studies on mutual funds. This particular study has far reaching implications for value of active fund management.
Yan has been conducting research as a professor at MU for four years, as well as teaching classes in investments and portfolio management to both undergraduate and graduate students.