Mutual fund performance evaluation: Index funds as an alternative investment tool

ABSTRACT Mutual funds are the institutional investors that play a key role in capital markets and that provide individual investors with investment(money management) services through professional portfolio management. Today, in developed markets, a large volume of the investment in stocks is carried out by mutual funds. Most money managers actively try to outperform each other and the market. Proponents of the efficient market hypothesis believe that active portfolio management is largely wasted effort and unlikely to justify the expenses incurred. Therefore, they advocate a passive investment strategy that makes no attempt to outsmart the market. One common strategy for passive management is indexing where a fund is designed to replicate the performance of a broad-based index of stocks and bonds. Funds that follow such an investment strategy are called index funds. An index fund is comprised of securities which in aggregate will produce a return replicating a designated securities index. The basic assumption behind index funds is that the market is efficient; that is, information is freely available for all investors and stocks are fairly priced. Therefore, investors cannot beat the market. In an efficient market, the "market portfolio" offers the highest level of return per unit of risk because ît captures the efficiency of the market. Index funds offer simplicity, diversification, strong relative performance, predictability, low cost, and average risk. This dissertation examines risk adjusted returns of actively managed portfolios and provides empirical evidence about excess returns of actively managed domestic funds(Type A Funds) over the market, represented by ISE-100 Stock Index, ISE-GDS Index, and a combination of the both. It was aimed to find out that whether it is worth to go all the trouble of searching for the right manager and paying extra fees to actively managed funds while it is possible to do better by investing in a passively managed fund that mirrors the performance of the market. The findings of the study show that actively managed funds(Type A Funds), on average, underperformed the market over the evaluation period, and indicate that index funds and indexing have some potential for Turkish capital markets. VI