Statistical analysis of mutual funds returns

Mutual Funds

An analysis of the correlations between the different independent variables and the return (%) of the fund shows the following results. The strongest correlation (0.783) is with product type. This finding is not surprising, because the risk characteristics of each fund are determined by the securities contained within. Assuming that any fund is going to be diversified, it should be expected that a strong correlation exists between total returns and asset class. Fixed income funds should return less than domestic funds. International funds should have returns that are consistent with each other more than they are consistent with domestic funds.

The second strongest correlation (0.558) is with expense ratio. Some correlation between expense ratio and total returns is expected, since the expense ratio is paid out of gross returns, thereby having a direct impact on net returns. There is a general expectation that that a higher expense ratio signals stronger management, but that is not necessarily the case, accounting for a lower degree of correlation -- the amount spent managing the fund is not necessarily reflective of its performance in any given year, or even over time.

There is also a correlation with the net asset value of the fund (0.415). This correlation is actually higher than expected. The NAV affects total returns because a higher NAV is more likely to have lower returns as a percentage. Lower NAV funds can exhibit strong swings in value with price movements that are the same as those of higher NAV funds. The correlation was expected to be relatively weak because even high value funds can experience exceptional performance.

The weakest correlation (0.056), which is not a significant correlation at all, is with the Morningstar rating. This is somewhat surprising, because the Morningstar rating presumably takes the fund's historical returns into consideration. However, in any given year the fund may or may not perform according to its track record. This could result in a divergence between the Morningstar rating and total returns.

There are also correlations noted between the type and the NAV and the type and the expense ratio. It should be expected that the latter would hold, because the cost of managing a fund is dependent on the cost of analyzing and trading the securities the fund. It would be expected, for example, that an international equity fund would cost more to manage than a fixed income fund.