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