Examining different facets of value creation in mutual funds
Do mutual fund managers create value for聽investors and the economy, and are they聽skilled at choosing the right companies to invest in, or not?
Through research funded by a Desmarais Faculty Scholar Award, Professor Laurent Barras is investigating questions that matter to聽a huge segment of the population. In a recent paper, 鈥淪kill, Scale聽and Value in the Mutual Fund Industry,鈥� Barras and his co-authors聽show that over 60 per cent of United States equity mutual funds聽failed to deliver superior performance for investors. However, fund聽managers created value, but mainly for themselves. 鈥淢anagers are聽skilled. But fees are too high compared to what managers bring to聽the table, so most of the performance value created goes to the聽fund managers rather than investors,鈥� said Barras.
The last 10 years have witnessed a dramatic change in the聽composition of the mutual fund industry, in which active funds聽have seen massive outflows while passively managed funds have had massive inflows. Barras is therefore collaborating with聽PhD student Pouya Behmaram and Desautels finance professor聽David Schumacher to examine the impacts of this huge structural聽change on actively managed funds in a follow-up paper-in progress:聽鈥淗ow do Active Funds React to the Rise of Passive聽Management?鈥�
Barras views the support for high-quality research through the聽Desmarais Faculty Scholar Awards to be creating benefit by also聽enhancing teaching. 鈥淚n my classes on applied investments, we聽look at the performance of mutual funds. Students work with all聽the data I鈥檝e collected to do differential analysis for investment聽returns. I can teach better classes because I鈥檝e studied this in my聽research and can share unique insights that I couldn鈥檛 get just from聽reading books,鈥� he said. 鈥淚 believe that research has a big impact in the class. I鈥檝e been an area coordinator in the finance group for the聽last two years and I see a strong connection between the research productivity of professors and the quality of their teaching.鈥澛犅�
As a first-time recipient, Barras has found that funding support聽and recognition provide an added incentive to tackle ambitious聽investment research problems and issues on a global scale. 鈥淭he聽Desmarais awards send an important signal that the Faculty is聽providing extra support for people who do great research, which聽is recognized internationally,鈥� said Barras. 鈥淭hat is crucial for聽retention policy, and it helps 平特五不中 and Desautels to keep their聽talented researchers.鈥�
Collaborating to investigate how聽credit default spreads
Default contagion is a major credit problem that affects companies, industries, and entire countries.
If one entity goes bankrupt it can increase risk and raise聽borrowing costs for other distressed borrowers, and tilt them聽toward default. Through research funded by a Desmarais聽Faculty Scholar Award, Professor Jan Ericsson has identified聽a new mechanism for default contagion and convincingly聽demonstrated how the transmission and spread of default聽risk can occur between borrowers that share no common聽economic fundamentals.
The funding enabled Ericsson to hire a gifted PhD finance聽student, Yiliu (Lucy) Lu, to collaborate on investigating and聽successfully pursuing a promising research idea. Ericsson and聽Lu developed a model which presents a new mechanism to聽explain how contagion arises and defaults can cluster when聽negative credit shocks that impact one borrower also damage聽the creditworthiness of other seemingly unrelated borrowers.
鈥淟ucy is brilliant and did the heavy lifting in computing to build聽the model. Without the funding, she couldn鈥檛 have been my聽student and that made it possible to pursue the research聽successfully,鈥� said Ericsson.
Their research findings are also useful for understanding how聽corporate and sovereign bailouts during crises can help prevent聽bankruptcy cascades by reversing those contagion spillover聽effects. The model may be relevant to the COVID-19 crisis in聽helping government policymakers assess default contagion聽risks and determine which firms, industries, or countries should聽benefit most from economic rescue packages.
As a recipient of four successive Desmarais Faculty Scholar聽Awards since 2010, Ericsson has broadened and deepened聽his research on risk premiums in corporate bond and credit聽derivative markets to tackle challenging problems.
鈥淎 lot of the efficiency of my research is based on the ability聽that the award gives me to hire talented students with the right聽expertise that can help. That鈥檚 extremely valuable,鈥� he said.
Ericsson also values the continuing opportunities to help聽advance the academic and research capabilities and聽aspirations of his students: 鈥淲hen you teach and work with a聽PhD student on an important research project, you are helping聽to shape their development as a future academic鈥攁s a teacher聽and researcher鈥攚hich is very satisfying both professionally聽and personally.鈥�
