Mark Hulbert in the New York Times reviews an intriguing academic paper on the performance of open-end mutual funds.

The study, called “Investing in Mutual Funds When Returns Are Predictable,â€? is forthcoming in the Journal of Financial Economics. Its authors are Doron Avramov and Russ Wermers, finance professors at the University of Maryland; a copy is at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=555462.

In the past, the professors say, most mutual fund research assumed that managers’ ability or inability to outperform the market was constant, regardless of the waxing and waning of the market cycle. But the professors made a different assumption: that significant numbers of managers may have market-beating ability at some stages of the economic cycle but not at others. A manager who can beat the market during a recession, for example, or in periods of high inflation, may well lag behind it in periods of robust economic growth or low inflation.

Despite the fact that most mutual funds end up underperforming their relevant benchmarks there may be some predictability in their performance that allows for investors to time their investment in mutual funds. The point being that given certain conditions certain types of funds will perform better than others. Rotating among funds that are predicted to do well, given this model, seems to be a profitable strategy.

This piece of academic research is intriguing and could be useful for
individual investors. There are two big caveats. The first is that this is a transaction-heavy process. The second is that this is a quantitatively intense process. The computations involved would be difficult for all but the most technologically savvy investor.

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