NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Evaluating and Investing in Equity Mutual Funds

Lubos Pastor, Robert F. Stambaugh

NBER Working Paper No. 7779*
Issued in July 2000
NBER Program(s):   AP

Our framework for evaluating and investing in mutual funds combines observed returns on funds and passive assets with prior beliefs that distinguish pricing-model inaccuracy from managerial skill. A fund's alpha' is defined using passive benchmarks. We show that returns on non-benchmark passive assets help estimate that alpha more precisely for most funds. The resulting estimates generally vary less than standard estimates across alternative benchmark specifications. Optimal portfolios constructed from a large universe of equity funds can include actively managed funds even when managerial skill is precluded. The fund universe offers no close substitutes for the Fama-French and momentum benchmarks.

*Published: Pastor, Lubog and Robert F. Stambaugh. "Investing In Equity Mutual Funds," Journal of Financial Economics, 2002, v63(3,Mar), 351-380.

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