Predictability of Fixed-Income Fund Returns

Potts, Tom; Reichenstein, William
November 2004
Journal of Financial Planning;Nov2004, Vol. 17 Issue 11, p62
Academic Journal
• Most prior research concluded that investors have no ability to predict bond mutual fund returns. This article's research suggests that on an absolute level of return and on a relative basis that returns can be partially predictable. • The reason much past research found no evidence of predictability is due to the nature of their fund samples. When funds are compared across styles, relative returns are largely unpredictable. This is so because returns for bearing duration risk and quality vary across time. • But when funds with similar styles are compared, longer-horizon relative returns are partially predictable. • The article's findings indicate that the five-year Treasury yield does an excellent job of predicting the five-year gross returns on high-grade intermediate-term bond funds. One-year returns, however, are largely unpredictable. • The study also found that differences among expense ratios predict about 80 percent of the differences in net returns among similar-style money market funds. • Among high-grade, long-term bond funds, expense ratios explain between 30 percent and 60 percent of differences in net returns over five-year periods. • Consequently, once investors pick a certain fixed-income style, they should seek a low-cost fund within that style.


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