Question

1. If you saw an advertisement for a mutual fund that consistently “beats the market” (pick stocks that do better than the overall market), what questions would you ask? You need to have at least three questions that you would ask for this question.

2. 90% of mutual funds that are active and trying to “beat the market” do NOT succeed over the long-term and yet close to 50% of mutual fund assets are invested in these active funds. Why do you think investors choose to invest this way?

Answer 1

A. The three main questions any informed investor would have in mind seeing a Mutual fund ad which consistently beats the market, i,e, pick stocks that do better than the overall marketould be as under:

1. History of such outperformance and whether the returns being showcased are before or after management fee since returns after accounting for such fee is usually nominal.

2. Criteria for choosing stocks to know if the MF is not baised towards a sector or industry which is recently doing well.

3. Persistence of the returns., i.e., likeliness of achieving outperformance in future sincepast returns are no guarantee of future outperformance

B. Investors believe that by choosing active funds, they may be able to meet or beat the index but often forget the tracking costs involved in active management. Such costs usually eat away most of the profits earned by the fund. Investors do this because they are not fully aware of such costs.