Passive versus active management of mutual funds: Evidence from the 1995–2008 period
Modern portfolio theory commenced the ensuing debate regarding the benefits of active versus passive management in regards to mutual funds. The two opposing mutual fund management styles claim that they produce superior risk-adjusted performance. The dissertation explores the research question: During the full 1995 to 2008 market cycle, which investment management style, active or passive, produced the better risk-adjusted performance?
The significance of this historic stock market period relates to the fact it contains the two greatest bull markets (1995-1999 & 2003-2007) followed by subsequent bear markets (2000-2002 & 2008). The study tested nine hypotheses, derived from the above research question, for the 5 different time periods (1995-1999, 2000-2002, 2003-2007, 2008, and 1995-2008).
Based on previous research, one would expect the passive management styles to out-perform the active styles during expansion whereas the performance would reverse during market contraction. The Sharpe composite portfolio performance measure, that combines risk and return into a single value, was used to measure, analyze, and rank risk-adjusted performance.
The study, comprised of 45 statistical tests, found that on a risk-adjusted basis that the active indices (proxies for active management) Sharpe ratios were significantly greater than those of the passive indices (proxies for passive management) Sharpe ratios for; (1) the midcap blend category for the periods 1995 to 2008 and 1995 to 1999; (2) the small blend category for the periods 1995 to 2008 and 1995 to 1999, and (3) the small value category for the periods 1995 to 2008, 1995 to 1999, and 2000 to 2002. Therefore, the active indices Sharpe ratio significantly exceeded the passive indices Sharpe ratio for 16% of the statistical tests conducted while the active indices Sharpe ratio did not significantly exceed the passive indices Sharpe ratio for 84% of the statistical tests conducted. The findings suggested that in the long run passive management produced better performance results than active management.